Foreclosure buyers got a Christmas Eve goodie from Fannie Mae, a new strategy that's likely to make foreclosure purchasing very much quicker. The catch? A bunch of lenders are about to be very unhappy.
Until the recent real estate meltdown, foreclosures were a problem but not too much of a problem. It was not unusual to sell foreclosed properties for the outstanding principal balance, meaning no losses for loan owners, no damages for mortgage insurers and no deficiency claims against owners.
But with the growing number of distressed properties there's now a substantial “foreclosure discount” in most markets. What were once tolerable and controlled losses are today steep and sharp declines that leave lender red ink everywhere. The question for loan owners is this: Is there anyway to make such lender losses smaller?
The answer, as we shall see, turns out to be good news for foreclosure buyers.
Quality Assurance Reviews
When a home is foreclosed one of the first steps taken by lenders and servicers is to figure out what they've got, a process which Fannie Mae calls a quality assurance review. That means getting estimates of value from local real estate brokers and appraisers, listing the property for sale and in some cases fixing up the property to maximize value.
Such steps make a lot of sense, but as they say on late night television: wait, there's more. There's also the little matter of taking another look at the documents used to originate the loan.
In today's mortgage marketplace it typically happens that a loan is originated by a local mortgage broker or lender and then sold on Wall Street, packaged with other loans and used to create a mortgage-backed security (MBS). Loans that are sold must be properly underwritten, an expression which means that all standards established by mortgage buyers such as Fannie Mae and Freddie Mac have been met.
The standards for conventional loans can include such benchmarks as 20 percent down or coverage by a mortgage insurance company, the verification of income and employment, a property appraisal and other measures. This is why mortgage buyers want carefully prepared loan application files and also why borrowers must complete IRS Form 4506, a permission slip of sorts that allows lenders and loan owners to look at borrower tax returns and compare them with income claims — even after the loan has been originated.
This all seems fairly routine except that some loan applications — and maybe more than some — have been below par. As one example, the FHA dropped more than 270 lenders during the past year.
So what happens when a loan application was not properly completed? The originating lender must buy back the loan if the borrower defaults within 120 days.
It might seem as though originating lenders have no liability after four months but that's not quite the case because there's a second rule that can come into play: Lenders must also buy back any loans which are a byproduct of origination fraud, a liability which continues until the loan is completely repaid.
So what is fraud? In basic terms “fraud” is an intentional deception that causes harm to someone else, say a mortgage investor.
It wasn't exactly a delivery from Santa, but on Dec. 24 Fannie Mae issued new guidelines for loan originators. Among the new rules was this little gem:
“When Fannie Mae receives an offer to purchase a property that is also subject to an underwriting or servicing review, Fannie Mae may accept the purchase offer without first notifying the servicer, whether or not a final decision has been reached with respect to the review. If, after completion of the review, Fannie Mae determines that the mortgage loan did not meet its eligibility or underwriting requirements and Fannie Mae has incurred a loss by selling the property, the lender will be required to fully reimburse Fannie Mae for its loss.”
Translated into plain language, the Fannie Mae announcement does several things:
- First, Fannie Mae is going to sell foreclosed properties as quickly as possible to cut inventory costs, even if that means not waiting for servicers to review sale offers. It should now be quicker and easier to complete a foreclosure sale because it will no longer be necessary to first run everything through clogged servicer review systems.
- Second, Fannie Mae is reserving the right sell foreclosures first and review loan application files later. Maybe months later. If irregularities are found then Fannie Mae will expect the originating lender to make up any losses.
- Third, you can quickly expect every other mortgage owner to adopt language similar to Fannie Mae's, thus speeding up foreclosure sales in general.
“Foreclosure sales are likely to move along at a faster clip because of the new Fannie Mae policy,” says Jim Saccacio, Chairman and CEO at RealtyTrac.com, the leading online marketplace for foreclosure properties and data. “But that very same policy also means loan applications are going to be far tougher. To avoid future liabilities mortgage originators will want to verify every dime and dollar claimed by borrowers. That will be irritating to some borrowers, but if the end result is a lending system with less risk then everyone will be ahead.”
Peter G. Miller is syndicated in more than 100 newspapers and operates the consumer real estate site, OurBroker.com.
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