When will Fannie and Freddie switch to a new credit-scoring model?

KENNETH R. HARNEY on Dec 2, 2016

WASHINGTON – You probably know that your credit score is a crucial factor in your ability to qualify for a mortgage. You might also know that your score can vary depending on the type of scoring model your lender uses. If it’s an old, outdated version you might get a lower score. If it’s a newer, more advanced model, you’ve got a better shot at being scored more fairly.

Which brings up an end-of-the-year controversy- The two behemoths of the mortgage business – Fannie Mae and Freddie Mac – continue to use a credit scoring model that even its developer, FICO, says is not as “predictive” as its much newer models. Worse yet, Fannie and Freddie require that all lenders who want to submit loan applications to them must also use the same, outdated technology.

The net result, say critics from the lending industry, consumer groups, civil rights organizations and a bipartisan coalition of legislators in Congress, is that many applicants don’t get the credit scores they deserve. Many other consumers – the estimates range above 30 million – aren’t even scoreable using the models currently employed at Fannie and Freddie. Disproportionately, critics say, these are people who don’t make heavy use of the credit system or who are young and don’t have much information on file with the national credit bureaus. Large numbers of them might qualify for a mortgage, say scoring experts, if they were simply given a fair shot.

Acknowledging the problem, Fannie’s and Freddie’s government regulator, the Federal Housing Finance Agency, directed the companies two years ago to begin examining how to improve their scoring systems. For 2016, the FHFA told them to “conclude [their] assessment,” and “as appropriate, plan for implementation” of a better approach.

Since it’s now December and there have been no announcements about possible reforms, I thought it appropriate to ask this question- When are Fannie and Freddie rolling out their new and improved scoring models and what will they look like? The question is especially timely given the release in late November of a new study from the Urban Institute documenting how recent credit standards in the mortgage arena have impacted millions of would-be borrowers.

Researchers found that roughly 1.1 million home loan applicants were turned down last year because the standards used to evaluate them have been much more stringent than they were in the pre-housing boom era, when defaults were relatively low. Between 2009 and 2015, “lenders would have issued 6.3 million additional mortgages,” researchers calculated, “if lending standards had been more reasonable,” as they were back in 2001.

A major culprit- a big shift toward the credit score elite when it comes to mortgage approvals. From 2001 through 2015, the share of borrowers approved for mortgages with FICO scores above 700 rose to 66 percent from 51 percent, while those approved with scores below 660 declined to just 14 percent from 31 percent. Credit scores of approved applicants at Fannie and Freddie this year alone have averaged between 752 and 754, according to loan technology firm Ellie Mae. Meanwhile, the average score among all Americans is just 699, according to score developer FICO. (FICO scores range from 300 to 850, with low scores indicating higher risks of default.)

In response to my question, a spokesperson for the FHFA told me that Fannie and Freddie continue to discuss their plans for scoring reforms with “a broad range of stakeholders” about the “cost, operational implications, and potential impacts on access to credit.”

Who are some of these “stakeholders” and how do they see this issue? Among the most directly affected are the banks and mortgage companies who deal with the two companies daily. They strongly favor a move to more advanced scoring models as a way to broaden the base of potential home buyers and borrowers without exposing themselves or Fannie and Freddie to higher risks of default.

Michael Fratantoni, chief economist for the Mortgage Bankers Association, told me in an interview that “by sticking to old models we are disadvantaging” sizable numbers of consumers. Groups such as Fratantoni’s also want to see the introduction of advanced scoring models from companies other than FICO – VantageScore Solutions, LLC offers a rival system now in use in most other segments of lending – as an option permitted by Fannie and Freddie.

“We are on the record for more competition in this space,” Fratantoni said. “We shouldn’t be locked into just one set of scores.”

Nor should potentially millions of credit-worthy consumers.

Freddie Mac planning appraisal-free mortgages

Kenneth R. Harney on Nov 11, 2016

WASHINGTON – Can computers, big data and advanced analytics replace real live humans when it comes to accurately valuing the home you want to buy? One of the two largest financial players in U.S. real estate thinks so and is preparing to introduce changes that could prove momentous – and highly controversial.

Giant mortgage investor Freddie Mac plans to dispense with traditional appraisals on some loan applications for home purchases, replacing them with an alternative valuation system that would be free of charge to both lenders and borrowers. The company confirmed to me last week that it could begin the no-appraisal concept as early as next spring. Instead of using professional appraisers, Freddie plans to tap into what it says is a vast trove of data it has assembled on millions of existing houses nationwide, supplement that with additional, unspecified information related to valuation, and use the results in its assessments of applications.

For consumers, the company believes, this could not only eliminate appraisal expenses – which typically range from $350 to $600 or more – but could cut down on current closing delays attributable to appraisals. It could also relieve lenders of their current burdens of responsibility for the accuracy of appraisals – a major sore point with banks that sell loans to Freddie subject to potential “buy back” demands if significant errors are later found in appraisals.

But critics argue that Freddie is headed down a perilous road. Doing away with formal appraisals by trained professionals could massively increase the company’s exposure to future losses on defaults, they say, and would likely end up being paid for by American taxpayers. Reliance on publicly available data without careful physical inspections of properties verges on “craziness,” said Joe Adamaitis, residential lending manager for Insignia Bank in Sarasota, Florida. “We would never allow it here.”

Not surprisingly, appraisers who know about the plans are up in arms. The Chicago-based Appraisal Institute, the largest professional group in the valuation field, has written to Freddie Mac’s regulator, Mel Watt, director of the Federal Housing Finance Agency, urging him to take a hard look. Freddie Mac’s “decision to veer away from fundamental risk management practices appears to harken back to the loan production-driven days in the years leading up to the 2007-2008 financial crisis” – abuses that “turned out to be disastrous for the entire economy,” the group wrote.

Veteran appraisers such as Pat Turner of Richmond, Virginia, believe that abandoning traditional valuation practices will leave Freddie Mac essentially “flying blind” in many instances. In a phone interview, he said he has inspected houses where the interior damage and neglect have been so extensive – none of it on public records or visible to automated systems – that the differences in market value arrived at by a computer compared with a trained professional are potentially catastrophic for any investor. Similarly, without an inspection, an automated valuation might not reflect whatever significant improvements you’ve made that are not on any public records.

For years an outspoken critic of the popular but frequently inaccurate automated valuation systems offered free by Zillow and other websites, Turner asked- “When was the last time a Zillow computer walked into your house?” Computerized estimates “can’t tell you everything you need to know about value,” said Turner.

But Freddie’s idea has strong defenders in the mortgage industry. Jay Farner, president of Quicken Loans, headquartered in Detroit and the second largest retail mortgage lender, told me “we’re in support of doing something to alleviate the situation today,” where appraisal delays can cause rate locks to expire and closings to be postponed.

Though “a large percentage of loans do require an appraisal,” he said, others could be safely underwritten with a combination of strong previous valuation data on the property, possibly combined with a “walk-through” inspection.

Bill Dallas, chairman and CEO of Skyline Financial Corp in Calabasas, California, calls the traditional use of appraisers “a really screwed up system.” He’d like to see the industry move toward an approach that makes maximum use of the huge property-specific databases built up from previous appraisals along with inspections when needed.

Where’s this all headed? We’ll begin to know in a few months. But don’t expect appraisers to suddenly disappear. The best of them add essential value to the process of telling a lender or investor what a house is truly worth, based on up-to-the-minute market information and a hands-on physical inspection – services no computer can perform, at least not yet.

FHA pulls housing head fake on condo communities

Kenneth R. Harney on Nov 4, 2016

WASHINGTON – Call it a housing policy head fake – one with potentially painful consequences for moderate-income buyers, sellers and seniors in hundreds of condominium projects around the country. If you were thinking about purchasing a condo unit with a low down payment FHA mortgage in the coming year, this could affect you.

Last week, ostensibly yielding to a congressional mandate to make consumer-friendly Federal Housing Administration mortgages more widely available in condominiums, the government announced a move to do precisely that- Starting immediately, projects with fewer than half of their units occupied by owners may be eligible for certification for FHA financing. Under “certain circumstances,” the government said, projects with as low as 35 percent owner occupancy might now be eligible.

Currently the minimum owner occupancy ratio is 50 percent – a level that critics in Congress and the real estate industry believe excludes too many first-time and minority buyers from access to FHA financing. FHA insists it needs such a threshold to avoid defaults and losses on mortgages. In July, legislation that passed Congress unanimously gave FHA 90 days to lower its owner-occupancy minimum to 35 percent or provide “justification” for keeping it higher.

That was important because historically, FHA has been the go-to option for consumers with modest resources. In some markets, FHA financing once accounted for upward of three-quarters of first-time purchases. Plus its reverse mortgage program accounts for an estimated 90-plus percent of all loans made to seniors needing to supplement their retirement incomes.

In recent years, however, the agency has severely tightened eligibility requirements for condominiums and has experienced drastic declines in the volume of condo loans as a result. Less than 10 percent of the estimated 150,000 potentially eligible condominium projects in the U.S. are now certified for FHA financing, according to the Community Associations Institute, a trade group. If a project is not certified by the FHA, no individual units within it can qualify for one of its loans.

Now for the head fake- In its announcement, FHA spelled out the conditions under which it would allow the lower owner-occupancy threshold. Condo boards of directors will have to document that their project’s financial reserves equal 20 percent or more of their budget and that no more than 10 percent of all units are in arrears on homeowner dues. Plus they must provide three years of “acceptable” financial documents for review.

How many non-certified condo projects can meet these tests? I asked FHA spokesman Brian Sullivan, who said in an email that although the agency is not certain, it believes that “many well-managed developments will indeed qualify for the lower 35 percent threshold.”

Sounds great. The million-member National Association of Realtors certainly thought so. Its president, Tom Salomone, hailed FHA’s policy switch as “a big win.”

But a closer look suggests something starkly different. FHA has created test criteria that appear virtually guaranteed to flunk most condo projects that might like to take advantage of the loosened standard. I spoke with the heads of four of the best-known consulting firms that work with condo boards nationwide to attain FHA certifications, plus a top official of the Community Associations Institute, which represents more than 30,000 homeowners associations and management companies. Everyone agreed- FHA’s policy change won’t help many projects or consumers who want to buy or sell units.

Christopher L. Gardner, managing member of California-based FHA Pros LLC, told me the 20 percent reserves requirement alone is a “deal killer.”

“I can probably count on two hands the number of associations I’ve seen that reserve 20 percent,” he said. “Homeowners hate their dues increased” and condo boards “hate to vote for increases because they want to stay on the board.” Locating projects that meet all the new criteria, he said, would be “like finding a unicorn holding a four-leaf clover.”

Rusty McInerney, president of InterIsland Mortgage Corp. of Bradenton, Florida, which has conducted more than 56,000 reviews of condo financials, said the request for three years of “acceptable” financial documents “is a Pandora’s box of ways” to reject an application.

Jon Eberhardt, president of Condo Approvals LLC, told me that “I don’t know one [project] that would fit” into FHA’s combined requirements. “Not one. It’s egregious,” he said.

Philip J. Sutcliffe, owner of Project Support Services in Philadelphia, who favors retention of the 50 percent owner-occupancy standard, said “very few, if any” projects will be able to pass the tests announced by FHA.

Bottom line- Congress may have instructed FHA to increase the number of condo units available for moderate income buyers, but apparently FHA had a different idea.

Court ruling could encourage realty payoff scheme revival

Kenneth R. Harney on Oct 21, 2016

WASHINGTON – A decision by a federal appellate court last week is casting new light on practices in the real estate field that buyers and sellers often know little about- Creative, under-the-table payoff schemes among realty brokers, mortgage lenders and title companies that can stifle market competition and raise settlement costs to consumers by hundreds or even thousands of dollars.

The court case involved a $109 million fine levied against mortgage lender PHH Corp. by the Consumer Financial Protection Bureau for allegedly violating the federal real estate anti-kickback statute through its mortgage insurance operations. PHH disputed the charges and filed suit, challenging not only the CFPB’s interpretation of the anti-kickback law, but the bureau’s constitutionality.

The constitutional challenge focused on the unusual structure of the bureau, which is headed by a single director who can only be terminated “for cause.” The court agreed with PHH on the statutory interpretation issue and ruled that henceforth the CFPB director would be like other executive branch agency heads – removable by the president at will.

Created by Congress in the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, the bureau has substantial oversight powers. During its short life, the CFPB has levied fines or provided financial relief to consumers totaling what it estimates to be in excess of $11 billion from banks and other entities accused of illegal activities.

Though the PHH case did not directly involve the types of fees-for-referrals practices that are widespread in the real estate industry, the ruling has called into question the legitimacy of the bureau’s regulatory interpretations on “marketing services agreements” and certain “affiliated business” relationships. In a typical marketing services agreement, a title company or lender agrees to pay a real estate broker or an individual agent fees for promotional assistance, say by prominently displaying a title company’s brochures or actively making recommendations about the benefits of using its services to home buyers.

The money involved can be significant – thousands of dollars a month in some cases. One title agency head who refuses to participate in such arrangements, Todd Ewing of Federal Title & Escrow, told me that the “going rate” quoted to him by a Washington D.C.-area real estate brokerage firm for marketing services was $15,000 per month. In exchange, the brokerage firm would steer new buyers to Ewing’s title firm.

Mark Greene, a loan originator for HomeBridge Financial Services in New Jersey, says that some large realty brokerage firms essentially “put it out for bid” – they ask lenders who’d like to receive referrals from their agents “what do you offer us?”

“It goes to the highest bidder,” he told me in an interview.

Late last year the CFPB issued a stern warning about marketing services agreements- Large numbers of them may violate the anti-kickback law, the Real Estate Settlement Procedures Act, known as RESPA. Based on the bureau’s investigative efforts, it said, “it appears that many [marketing services agreements] are designed to evade RESPA’s prohibitions against kickbacks and unearned fees.” As a result of the bureau’s statement, some major lenders said that they were terminating whatever marketing services arrangements they had to avoid the risk of being hit with penalties by the CFPB.

But now, in the wake of the PHH decision that calls into question the CFPB’s interpretations of RESPA, there are concerns in the industry that some companies no longer will feel constrained and could return to old referral scheme practices or invent new ones.

One legal expert on RESPA, Marx Sterbcow of New Orleans, told me “my fear is that we’re going to see [companies] think ‘OK, now there are no more rules,” leading to a resurgence of illegal payoff schemes. That, in turn, could “destabilize markets” – harming lenders and title companies who refuse to make referral payments – and expose consumers to needlessly higher settlement charges.

What can you do to avoid settlement cost rip-offs? Sterbcow recommends you ask this question of any realty agent who seems to be nudging you toward a specific title agency or lender- “Does your broker or do you have any type of business relationship with this company?” Ask for any written disclosure about the relationship, which may be tucked away with other boiler-plate documents you received, and easy to miss.

Most important of all- Always shop the market aggressively for your mortgage, title and settlement services. Compare quotes. When service providers aren’t paying for what may amount to referrals, they often can offer you better prices.

Court ruling could encourage realty payoff scheme revival

Kenneth R. Harney on Oct 21, 2016

WASHINGTON – A decision by a federal appellate court last week is casting new light on practices in the real estate field that buyers and sellers often know little about- Creative, under-the-table payoff schemes among realty brokers, mortgage lenders and title companies that can stifle market competition and raise settlement costs to consumers by hundreds or even thousands of dollars.

The court case involved a $109 million fine levied against mortgage lender PHH Corp. by the Consumer Financial Protection Bureau for allegedly violating the federal real estate anti-kickback statute through its mortgage insurance operations. PHH disputed the charges and filed suit, challenging not only the CFPB’s interpretation of the anti-kickback law, but the bureau’s constitutionality.

The constitutional challenge focused on the unusual structure of the bureau, which is headed by a single director who can only be terminated “for cause.” The court agreed with PHH on the statutory interpretation issue and ruled that henceforth the CFPB director would be like other executive branch agency heads – removable by the president at will.

Created by Congress in the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, the bureau has substantial oversight powers. During its short life, the CFPB has levied fines or provided financial relief to consumers totaling what it estimates to be in excess of $11 billion from banks and other entities accused of illegal activities.

Though the PHH case did not directly involve the types of fees-for-referrals practices that are widespread in the real estate industry, the ruling has called into question the legitimacy of the bureau’s regulatory interpretations on “marketing services agreements” and certain “affiliated business” relationships. In a typical marketing services agreement, a title company or lender agrees to pay a real estate broker or an individual agent fees for promotional assistance, say by prominently displaying a title company’s brochures or actively making recommendations about the benefits of using its services to home buyers.

The money involved can be significant – thousands of dollars a month in some cases. One title agency head who refuses to participate in such arrangements, Todd Ewing of Federal Title & Escrow, told me that the “going rate” quoted to him by a Washington D.C.-area real estate brokerage firm for marketing services was $15,000 per month. In exchange, the brokerage firm would steer new buyers to Ewing’s title firm.

Mark Greene, a loan originator for HomeBridge Financial Services in New Jersey, says that some large realty brokerage firms essentially “put it out for bid” – they ask lenders who’d like to receive referrals from their agents “what do you offer us?”

“It goes to the highest bidder,” he told me in an interview.

Late last year the CFPB issued a stern warning about marketing services agreements- Large numbers of them may violate the anti-kickback law, the Real Estate Settlement Procedures Act, known as RESPA. Based on the bureau’s investigative efforts, it said, “it appears that many [marketing services agreements] are designed to evade RESPA’s prohibitions against kickbacks and unearned fees.” As a result of the bureau’s statement, some major lenders said that they were terminating whatever marketing services arrangements they had to avoid the risk of being hit with penalties by the CFPB.

But now, in the wake of the PHH decision that calls into question the CFPB’s interpretations of RESPA, there are concerns in the industry that some companies no longer will feel constrained and could return to old referral scheme practices or invent new ones.

One legal expert on RESPA, Marx Sterbcow of New Orleans, told me “my fear is that we’re going to see [companies] think ‘OK, now there are no more rules,” leading to a resurgence of illegal payoff schemes. That, in turn, could “destabilize markets” – harming lenders and title companies who refuse to make referral payments – and expose consumers to needlessly higher settlement charges.

What can you do to avoid settlement cost rip-offs? Sterbcow recommends you ask this question of any realty agent who seems to be nudging you toward a specific title agency or lender- “Does your broker or do you have any type of business relationship with this company?” Ask for any written disclosure about the relationship, which may be tucked away with other boiler-plate documents you received, and easy to miss.

Most important of all- Always shop the market aggressively for your mortgage, title and settlement services. Compare quotes. When service providers aren’t paying for what may amount to referrals, they often can offer you better prices.