Mortgage originators need to be more concerned about defects in the loan manufacturing process and not rely on representations and warranties or insurance policies as a cure.
What is happening today in the loan creating-process is scarcely different from what was going on prior to the housing crisis. Instead of adequately dealing with problems in the files prior to the loan closing, the industry still depends on mechanisms that make corrections after closing. That may be too late in the process.
The Federal Housing Administration along with Fannie Mae and Freddie Mac all have stated they want originators to reduce or even eliminate defects when creating a loan.
But lenders are not using all the tools available in the market today that weren’t there before the crisis to validate loan file data, noted Greg Holmes, the national director of sales and marketing at Credit Plus. His Salisbury, Md., firm provides credit reports and verification services to mortgage originators.
“There is a concern for the rising cost of buying this data…but it is a small price to pay to avoid” problems with the file, said Holmes.
“We can solve the problem up front with a very inexpensive data validation tool that would prevent potential loss on the back end.”
To eliminate avoidable errors in loan files, originators need to document everything they can, and verify information. Things get overlooked because people make assumptions about how current the data truly is, Holmes said.
Sometimes lenders will accept the tax return as the verification of income and look at the last two years’ filings. “All that tells you is what the borrower earned up until the end of last year. So you don’t know in this case what people have earned between January and September,” Holmes said. These lenders do not do a verification of employment (which is available through services like The Work Number) or get the applicant’s year-to-date current income.
This spring, the private mortgage insurer Radian Group Inc. purchased Clayton Holdings, which performs loan reviews and due diligence. That deal provided some context to statements made by Radian’s CEO S.A. Ibrahim during an earlier investor presentation.
“One of the things that came out of the downturn,” he said, “a big lesson for all of us, including people have been in the industry for a long time, is for too long, we did not place as much importance on defective loans and loans being negligently serviced…during the downturn.
“It started out with our looking at loans and saying ‘they have acceptable credit standards, why aren’t they performing?’ and finding out that they had not been originated properly or not being serviced properly.
“To the extent that the industry can get better at understanding, managing surveillance and staying on top of that risk, we think we can systematically improve the industry performance. That’s been a neglected area,” Ibrahim commented.
Third-party loan reviews have become stronger and more relevant in the market after the mortgage crisis and have an advantage over typical representations and warranties for securitizations, a report from Moody’s Investors Service vice president and senior credit officer Yehudah Forster states.
These reviews identify defects in the loan that the originator can cure before the securitization closes. But, they are performed after the loan is funded in the first place.
Forster noted flaws in the reviews. They could inadequately disclose problems or miss well-hidden fraud, for example. And if in the future the market elects to decrease the loan review sample size to save time and money, problems could be missed and reps and warranties could be the only remedy.
The reality might be that lenders are just not concerned with the creation of a zero-defect mortgage.
The leading concern of Quality Mortgage Service’s clients during the prefunding stage is whether they are creating a loan which is sellable on the secondary market, said Tommy Duncan, the CEO of the Brentwood, Tenn., conductor of quality control audits. These clients want a yes or no answer.
“What they don’t have is the time or resources” to respond to small errors at prefunding level. Loan salability is the concern, not dealing with minor errors.
“Do we major in the minors or do we major in the majors? Are we at a point in our industry that we are going to major in the minors for that perfection?” asked Duncan.
Still, according to QMS data, mistakes on the application were the No. 2 source of errors for mortgage originators during 2013 and so far this year. The No. 1 problem is disclosure errors.
Even so, there has been year-over-year improvement in the number of application errors, QMS found. This could be because of the growth in the use of online applications and situations where the borrower is able to order his or her own credit report and other services, Duncan speculated.
The secondary market is more concerned about risk rather than compliance defects, Duncan said. “They’re not going to be chasing someone down because they had a typo, nor had some items missing from the application,” he said; rather investors want to see the items that support the underwriting decision for the loan.