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Housing Finance Policy Springs to Life: Distinguishing Policy Aspiration from Policy Action

Spring is in full blossom in Washington, and with it has come a great deal of activity on the housing finance front.  Congress has been busy with hearings on housing finance reform, the budgets of federal agencies, and other housing-related issues.  In addition, the President issued a memorandum instructing the Secretaries of the Department of the Treasury and the Department of Housing and Urban Development to create plans for the reform of the government-sponsored enterprises (GSEs), the Federal Housing Administration (FHA), and the Government National Mortgage Association (GNMA or Ginnie Mae).  Also, Mark Calabria has been confirmed and seated as Director of the Federal Housing Finance Agency (FHFA).  Finally, FHA and VA recently announced updates to their handbooks and other policies.

While GSE reform efforts have garnered the bulk of the housing finance related press of late, it was a quietly announced change by FHA that arguably poses a more immediate impact to mortgage lending.  On March 14, FHA notified lenders that it would be making changes to its TOTAL (Technology Open to Approved Lenders) Mortgage Scorecard to better manage risk layering resulting from borrowers with low credit scores and high debt-to-income (DTI) ratios.  As is clear from the chart below, FHA has definitely seen significant growth in loans with low credit scores and high DTIs.  So it was prudent for FHA to take action to protect its insurance fund from the elevated risk associated with loans bearing these characteristics.

The TOTAL Mortgage Scorecard is “a statistically derived algorithm developed by HUD to evaluate borrower credit history and application information” that integrates with a lender’s automated underwriting system (AUS).  All forward mortgage loans, with the exception of Streamline Refinance loans and assumptions, must be scored through TOTAL.  TOTAL renders a score of “Accept” or “Refer”, and loans that receive a Refer classification must be manually underwritten.

What does all of this mean for lenders?  While FHA alluded to a previously rescinded policy that required all loans with borrower credit scores below 620 and DTIs in excess of 43% to be manually underwritten, the March 14 announcement did not specify the exact changes that would be made to TOTAL to address risk layering concerns.  However, an analysis of fiscal year 2018 data for loans with credit scores below 620 and DTIs greater than 43% reveals that changes to TOTAL for loans with those characteristics could impact roughly 40,000 loans per year, or approximately $8 billion in production.

At a time when the industry is struggling with declining origination volumes and continued margin compression, changes to FHA’s TOTAL Mortgage Scorecard present additional challenges for lenders.  The possibility for as many as 40,000 loans to be ineligible for FHA-insured financing could exacerbate an already significant drop in production, while an increase in the number of loans requiring manual underwriting will put additional pressure on lenders’ costs to originate.  Although FHA’s proposed changes won’t be catastrophic for mortgage lending, they present yet another headwind for the industry.

With all of the recent housing finance news emanating from Washington, lenders must endeavor to distinguish policy aspirations from policy actions.  While we may all want to see comprehensive housing finance reform, the likelihood is slim of a deeply divided Congress achieving a grand bargain on a complex and contentious issue like GSE reform – especially as we approach an election year.  But administrative changes like those announced by FHA for the TOTAL Mortgage Scorecard have the potential to shift market dynamics in noticeable ways right now.  To borrow from Public Enemy, “Don’t believe the hype.”  The changes that matter most may not be the ones that get the most press.

By Nate Shultz: As Vice President of Government and Regulatory Affairs for TMS, Shultz  is one of the nation’s largest and fastest growing independent mortgage banks. Previously, he has served in leadership roles at the Colorado Housing and Finance Authority and at the Federal Housing Administration.

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April 17, 2019