FHA Clarifies Lender Indemnification Process and Performance Expectations

The Department of Housing and Urban Development (HUD) is preparing to take another step toward tighter authority and oversight of its approved lenders. The FHA has requested comment on regulatory changes that will strengthen its ability to force lenders to indemnify or reimburse the FHA for claims against the insurance fund.  HUD is also proposing new rules that would increase performance standards for FHA's authorized lenders.

Last January, FHA announced a series of policy changes to address risk and strengthen the financial position of its insurance fund and the agency has also moved to fine and sanction many of its lenders. The latest proposed changes are intended to create a regulatory framework and codify the legal authority FHA currently has under the National Housing Act.

The proposed changes were published in the Federal Register on Friday and stakeholders are invited to comment.  One area in which changes are proposed is lender indemnification to HUD of insurance claims where the lender is guilty of fraud, misrepresentation or noncompliance with applicable loan origination requirements.  Under existing rules, indemnification is required when a claim arises in connection to a mortgage that was not "originated" in accordance with FHA requirements.  The new rule would expand the definition of "originate" to include the entire process from application to the endorsement of the mortgage note.  Indemnification is required at any time when a mortgage loss results from fraud, however, indemnification in other cases such as non-compliance is currently limited to "a reasonable time period" after origination.  The new rules will codify the time limit at five years.

The specific instances of failing to comply with FHA requirements which can result in a demand for indemnification are a failure to:

• Verify or analyze creditworthiness, income and/or employment of the mortgagor;
• Verify the source of assets used for a down payment and/or closing costs;
• Address property deficiencies identified in the appraisal which could affect the health and safety of the occupants or the structural integrity of the building
• Certify that the appraisal was done in compliance with FHA appraisal requirements.

HUD may seek indemnification whether or not the violation caused the mortgage default.

The current method of defining acceptable default rates for initial lender approval sets a two year baseline for defaults and claims based at or below 150 percent of either the national average rate of defaults and claims for all insured mortgages or, if the lender operates in a single state, that state's average default rate.  This methodology may disadvantage lenders operating in multiple states (and thus using the national average) where one of those states has an unusually high default rate.  The proposed rule will set default rates state-by-state for multiple state lenders.  The new rules will also require that lenders continually maintain the claim and default rates that were required when their authority was initially granted and requires that HUD continually monitor the lender's performance. 

Under current rules, the lack of a proven track record makes new lenders ineligible for Lender Insurance authority however this also applies to new entities that are created by merger, acquisition or reorganization even where one of the participating parties previously had Lender Insurance approval.  Approval in such cases required an individual waiver.  Under proposed rules, HUD would be able to evaluate the potential performance of the new entity based on the performance of the predecessor corporate entity or entities providing it held Lender Insurance approval at the time of the acquisition or merger.

"It's important that our expectations are crystal clear," said FHA Commissioner David H. Stevens of the changes. "We need to clarify which circumstances we'll require indemnification and the level of loan performance we expect lenders to maintain."

In addition to soliciting comments on the changes outlined above, HUD is also seeking input on a proposal to require mandatory electronic submission of case binders.  The current regulation requires that mortgagees maintain records, including origination files, and submit them to HUD within 60 days of the loan closing.  Customarily these case binders are maintained and submitted to HUD in hard-copy paper format.  HUD is now considering requiring that all case binders be submitted electronically after June 2012.

Comments on any of the proposed changes will be accepted from interested parties until December 7, 2010. Here’s how you can provide feedback:

1. GO HERE: FR-5156-P0-1 Federal Housing Administration Single Family Lender Insurance Process; Eligibility, Indemnification, and Termination
2. Click on the "Submit a Comment" link
3. Fill-in your information, and enter your comment.
4. Hit “submit” and let your voice be heard.