Summary

The housing boom has lasted longer than housing bears have expected, with shares of homebuilders seeing significant gains.

The iShares Home Construction ETF is up 33% for the year and SPDR S&P Homebuilders ETF has a 27% YTD return.

Why won’t the housing market turn when every economic indicator says it should? I’d argue that new home sales have held up largely because of homebuilders offering buyers teaser rates.

Homebuilders are using short-term mortgage buydowns to attract buyers, but this could lead to chaos as payments automatically reset to higher amounts. This is particularly risky for jumbo mortgages.

I estimate that 600,000 to 700,000 households could face rate resets in the next year, which could quietly put pressure on the economy and housing market.

Recent data shows what was a surprisingly strong spring selling season for homebuilders and an existing home sales market that has rebounded in price, even amidst plunging volumes. For shares of homebuilders, this means that the pandemic boom in new construction has carried on longer than most analysts thought it would. The iShares Home Construction ETF (BATS:ITB) is up roughly 33% for the year, and the SPDR S&P Homebuilders ETF (NYSEARCA:XHB) also clocks in at a 27% YTD return. Over the full business cycle, however, publicly traded homebuilders are lousy businesses. Homebuilders are highly leveraged, highly cyclical businesses. Historically, they’ve had poor returns on capital compared with the market at large and tend to go bust during recessions– a fact that is somewhat hidden by survivorship bias when looking at historical returns.

More recently in 2022, this led to the question of whether homebuilders trading for 5x peak earnings or so were good value investments or value traps. I’ve repeatedly taken the position that they’re value traps, but now here we are with homebuilder stocks having rocketed back to all-time highs since the October lows, along with many of the most speculative corners of the market.

The one factor that I massively underestimated was the prevalence of short-term mortgage rate buydowns provided by homebuilders. How these typically work is that builders will buy down borrowers’ mortgage rates for 1-3 years, at which point the mortgage resets to a higher monthly payment. Common forms include 3-2-1 (i.e. 3% reduction in interest in year 1, 2% in year 2, and 1% in year 3), and 2-1.

Research shows that around 75% of builders are using them, with the greatest concentrations of use in Texas and the Southwest. On a $500,000 loan with a 2-1 and prevailing mortgage rates at 7%, the monthly payment would be $2,684 in year 1, $2,997 in year 2, and $3,326 in year 3. By and large, this allowed builders to sell homes that would have piled up by offering teaser payments that reset to levels that are technically legal, but often at rather uncomfortable debt-to-income ratios when combined with property tax increases and skyrocketing utility bills. Throw in some cheap construction and 110-degree summer temperatures, and you have a recipe for potential regret, especially for out-of-state buyers.

Fannie Mae and Freddie Mac restrict buydowns that exceed these thresholds (because of the potential for fraud and abuse), but highly publicized troubles at lenders like First Republic (OTCPK:FRCB) show that the jumbo market has seen some more exotic underwriting. The unspoken implication here is that lenders, real estate agents, and builders are selling these to buyers with the implicit or explicit suggestion that they should refinance down the road and lower their payments, (a.k.a. the infamous “date the rate, marry the house” sales pitch). That works if interest rates go down, but interest rates have actually gone up and the Treasury now has a boatload of deficit-financed debt to sell, which threatens to push mortgage rates above 8% by late summer. Fannie Mae and Freddie Mac at least force buyers to qualify for the payments after they reset, but it’s not clear whether the jumbo market has the same level of protection.

Mortgage buydowns may be innovative for builders, but they’re not newly invented. One of the untold stories of the 2008 financial crisis was the role that homebuilder rate incentives had in fueling the crisis. Adjustable rate mortgages get all the attention for massive balloon payments, but the story in jumbo mortgages was actually quite similar. Many, many buyers who bought in 2005 and 2006 had their mortgages reset in 2008 and 2009 after their rate buydowns expired, and their assumptions about mortgage rates turned out to be wildly wrong. In fact, jumbo mortgage rates hit nearly 8% in early 2009. That’s because jumbo mortgages are heavily dependent on credit, which rapidly tightened then starting in 2007 and also is tightening now. Only after the economy recovered did mortgages start to get cheaper again.

This means that taking out a jumbo mortgage because you think you can refinance it later is riskier than you think! It’s smart for homebuilders to offer these and it extended the business cycle long enough for investors to make profits. However, these rate resets are potentially disastrous for buyers making huge economic bets with scarce information about whether they’ll truly be able to refinance for cheaper rates.

Jumbo Mortgage Rates- 2007-2013

Different data sources on mortgages will generally show slightly different numbers, the main reason being that many mortgage rate surveys don’t count points charged to acquire the loan. But jumbo mortgage rates rose in the early stages of the 2000 recession. And throughout the 2008 recession, we see here that jumbo mortgages actually rose significantly.

So how many people have these rate buydowns? A minority of builders do buy the rate down for the whole 30-year term and a few buyers pay cash, so I think a fair estimate is that roughly 50% of new home buyers have rate buydowns that are 3-2-1 or faster. Roughly 600,000 new homes were sold in 2022, and this year is tracking for about 800,000. Divide by two, and we can ballpark that maybe 600,000 to 700,000 households have rate reset balloon payments coming due over the next couple of years. It may not sound like much, but that’s a figure roughly equal to all of the homes in the US currently listed for sale. Since housing supply for sale is low compared to the size of the overall housing stock, it could change the supply/demand dynamics considerably. My guess is that this will start to quietly become a problem for new homeowners, as we’re just now starting to see rates reset from last summer when mortgage rates first hit 6%.

For jumbo buyers, these can amount to payment hikes of $1,000 to $2,000 per month. Jumbo buyers aren’t likely to get much sympathy from the Fed or Treasury either, as encouraging marginal holders to sell is part of the process of bringing supply and demand back into balance. The strategy of taking out a mortgage and trying to refinance is somewhat better for those buying lower-priced homes with conventional mortgages. At lower mortgage amounts, the government is more likely to intervene to help you if things go south. Still, I wouldn’t expect a whole lot of help without unemployment rising sharply, in which case many buyers will need to sell anyway, driving down prices. Now add student loans restarting, with 40 million borrowers affected. Interesting times indeed.

The Cure For High Prices Is High Prices

While homebuilders have done well, the looming oversupply in rental housing and falling margins for homebuilders will continue to accelerate. If current trends hold, new homes could soon be cheaper than existing homes, which almost never happens. Builders are aggressively discounting homes, including using rate buydowns, and it’s allowing them to offload houses.

But as a recent report from Reventure Consulting shows, much of this new construction is far out from existing cities, which may help explain why there has been relatively little pressure on the existing home sales market so far. For example, this is a map of new construction in North Texas, where much of the new construction is an hour or longer drive to the city itself. In the 2008 real estate bubble, these kinds of homes were the hardest hit, particularly in areas like Arizona, Las Vegas, and the Inland Empire of California.

But with the median prices of new homes falling from $497,000 at the pandemic peak to $416,000, it’s only a matter of time before buyers start responding in earnest to the market signal they’re being given. As prices for new construction continue to fall, it’s going to pressure the existing home sales market because the two are nearly perfect substitutes. And ask yourself, with new home prices already falling to near the levels of existing homes, who’s going to buy the next 1.7 million units under construction, and at mortgage rates of 7% or more?

Homebuilders clearly had some hefty profit margins to work with in 2022 when they began discounting inventory. But the next 1.7 million houses under construction will be a much tougher proposition to sell or rent. Rents are now falling, interest rates continue rising, and there’s little long-term demographic demand for housing in excess of what’s already been pulled forward. While housing market bears may have been early in calling a downturn, underlying demographic trends likely mean they won’t be wrong about the ultimate destination.

With these in mind, I’m highly skeptical of stocks like Lennar (LEN) now trading for 10.5x earnings, D.R. Horton (DHI) trading for 11.5x earnings, and even from Toll Brothers (TOL) trading for 7.8x. If builders want to buy down mortgages for the full 30-year term for borrowers it’s fine, but doing so affects margins similarly to how price cuts would. When most of the industry is offering short-term teaser rates to new home buyers, the very clear risk is that the houses they sell come back onto the market when the mortgages reset, just like they did in the 2000s, but on a smaller scale. This, combined with the massive wave of construction hitting the market means homebuilder profit margins likely won’t stop falling when they hit 0%.

Key Takeaways

The housing market has been surprisingly strong in 2023, despite the ratio of a typical mortgage payment to a typical wage reaching a level surpassing the 2000s housing bubble.

One reason that the housing market hasn’t turned down as sharply as feared may be due to widespread mortgage rate buydowns by builders.

Many buyers are rolling the dice and betting that they can refinance in a couple of years for a lower interest rate before their payments reset, but jumbo mortgage rates in particular tend to rise, not fall during a recession.

Will home buyers who bought in 2022 with mortgage buydowns sell en masse when their payments reset this year and next? We’ll see.

It remains to be seen whether the economy will achieve a soft landing, but the widespread existence and adoption of mortgage rate buydowns are likely to exacerbate the swings of the business cycle. Count this as one more data point suggesting a soft landing is less likely than pundits think.

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.

Source : https://seekingalpha.com/article/4617622-us-homebuilder-mortgage-rate-buydowns-starting-to-expire

The Maryland governor recently signed HB 1150 (the “Act”), which subjects certain shared appreciation agreements (SAAs) to the Maryland Mortgage Lender Law. Under the Act, the term “loan” now “includes an advance made in accordance with the terms of a shared appreciation agreement.” An SAA is defined by the Act to mean “a writing evidencing a transaction or any option, future, or any other derivative between a person and a consumer where the consumer receives money or any other item of value in exchange for an interest or future interest in a dwelling or residential real estate, or a future obligation to repay a sum on the occurrence of [certain] events,” such as an ownership transfer, a repayment maturity date, a consumer’s death, or other events. The Act specifies that a loan is subject to the state’s mortgage lender law if the loan is an SAA and “allows a borrower to repay advances and have any repaid amounts subsequently readvanced to the borrower.”

Interim guidance released by the Maryland Commissioner of Financial Regulation further clarifies that SAAs are mortgage loans, and that those who offer SAAs to consumers in the state are required to obtain a Maryland mortgage lender licensing unless exempt. Under the Act, the commissioner will issue regulations addressing enforcement and compliance, including SAA disclosure requirements. The Act takes effect July 1. However, for SAA applications taken on or after July 1 (and until regulations are promulgated and effective), the commissioner will not cite a licensee for disclosure requirement violations, provided the licensee makes a good faith effort to give the applicant specified information within ten days of receiving an application. Licensees will be required to provide the information again at least 72 hours before settlement if the actual terms of the SAA differ from those provided in the initial disclosure.

WASHINGTON, D.C. – Four federal agencies jointly pledged today to uphold America’s commitment to the core principles of fairness, equality, and justice as emerging automated systems, including those sometimes marketed as “artificial intelligence” or “AI,” have become increasingly common in our daily lives – impacting civil rights, fair competition, consumer protection, and equal opportunity.

The Civil Rights Division of the United States Department of Justice, the Consumer Financial Protection Bureau, the Federal Trade Commission, and the U.S. Equal Employment Opportunity Commission released a  joint statement outlining a commitment to enforce their respective laws and regulations.

All four agencies have previously expressed concerns about potentially harmful uses of automated systems and resolved to vigorously enforce their collective authorities and to monitor the development and use of automated systems.

“Technology marketed as AI has spread to every corner of the economy, and regulators need to stay ahead of its growth to prevent discriminatory outcomes that threaten families’ financial stability,” said CFPB Director Rohit Chopra. “Today’s joint statement makes it clear that the CFPB will work with its partner enforcement agencies to root out discrimination caused by any tool or system that enables unlawful decision making.”

“We have come together to make clear that the use of advanced technologies, including artificial intelligence, must be consistent with federal laws,” said Charlotte A. Burrows, Chair of the EEOC. “America’s workplace civil rights laws reflect our most cherished values of justice, fairness and opportunity, and the EEOC has a solemn responsibility to vigorously enforce them in this new context. We will continue to raise awareness on this topic; to help educate employers, vendors, and workers; and where necessary, to use our enforcement authorities to ensure AI does not become a high-tech pathway to discrimination.”

“We already see how AI tools can turbocharge fraud and automate discrimination, and we won’t hesitate to use the full scope of our legal authorities to protect Americans from these threats,” said FTC Chair Lina M. Khan. “Technological advances can deliver critical innovation—but claims of innovation must not be cover for lawbreaking. There is no AI exemption to the laws on the books, and the FTC will vigorously enforce the law to combat unfair or deceptive practices or unfair methods of competition.”

“As social media platforms, banks, landlords, employers, and other businesses that choose to rely on artificial intelligence, algorithms and other data tools to automate decision-making and to conduct business, we stand ready to hold accountable those entities that fail to address the discriminatory outcomes that too often result,” said Assistant Attorney General Kristen Clarke of the Justice Department’s Civil Rights Division. “This is an all hands on deck moment and the Justice Department will continue to work with our government partners to investigate, challenge, and combat discrimination based on automated systems.”

Today’s joint statement follows a series of CFPB actions to ensure advanced technologies do not violate the rights of consumers. Specifically, the CFPB has taken steps to protect consumers from:

Black box algorithms: In a May 2022, circular the CFPB advised that when the technology used to make credit decisions is too complex, opaque, or new to explain adverse credit decisions, companies cannot claim that same complexity or opaqueness as a defense against violations of the Equal Credit Opportunity Act.

Algorithmic marketing and advertising: In August 2022, the CFPB issued an interpretive rule stating when digital marketers are involved in the identification or selection of prospective customers or the selection or placement of content to affect consumer behavior, they are typically service providers under the Consumer Financial Protection Act. When their actions, such as using an algorithm to determine who to market products and services to, violate federal consumer financial protection law, they can be held accountable.

Abusive use of AI technology: Earlier this month, the CFPB issued a policy statement to explain abusive conduct. The statement is about unlawful conduct in consumer financial markets generally, but the prohibition would cover abusive uses of AI technologies to, for instance, obscure important features of a product or service or leverage gaps in consumer understanding.

Digital redlining: The CFPB has prioritized digital redlining, including bias in algorithms and technologies marketed as AI. As part of this effort, the CFPB is working with federal partners to protect homebuyers and homeowners from algorithmic bias within home valuations and appraisals through rulemaking.

Repeat offenders’ use of AI technology: The CFPB proposed a registry to detect repeat offenders. The registry would require covered nonbanks to report certain agency and court orders connected to consumer financial products and services. The registry would allow the CFPB to track companies whose repeat offenses involved the use of automated systems.

The CFPB has also launched a way for tech workers to blow the whistle. The CFPB encourages engineers, data scientists and others who have detailed knowledge of the algorithms and technologies used by companies and who know of potential discrimination or other misconduct within the CFPB’s authority to report it. CFPB subject-matter experts review and assess credible tips, and the CFPB’s process ensures that all credible tips receive appropriate analysis and investigation.

The CFPB will continue to monitor the development and use of automated systems, including AI-marketed technology, and work closely with the Civil Rights Division of the DOJ, FTC, and EEOC to enforce federal consumer financial protection laws and to protect the rights of American consumers, regardless of whether legal violations occur through traditional means or advanced technologies.

The CFPB will also release a white paper this spring discussing the current chatbot market and the technology’s limitations, its integration by financial institutions, and the ways the CFPB is already seeing chatbots interfere with consumers’ ability to interact with financial institutions.

Read today’s Joint Statement on Enforcement Efforts Against Discrimination and Bias in Automated Systems. 

Read Director Chopra’s Prepared Remarks on the Interagency Enforcement Policy Statement on “Artificial Intelligence.”

Consumers can submit complaints about other financial products and services, by visiting the CFPB’s website or by calling (855) 411-CFPB (2372).

Employees who believe their company has violated federal consumer financial laws, including violations involving advanced technologies, are encouraged to send information about what they know to whistleblower@cfpb.gov. To learn more about reporting potential industry misconduct, visit the CFPB’s website.

The Consumer Financial Protection Bureau (CFPB) is a 21st-century agency that helps consumer finance markets work by making rules more effective, by consistently and fairly enforcing those rules, and by empowering consumers to take more control over their economic lives. For more information, visit www.consumerfinance.gov.

Source: https://www.consumerfinance.gov/about-us/newsroom/cfpb-federal-partners-confirm-automated-systems-advanced-technology-not-an-excuse-for-lawbreaking-behavior/

March 23 (Reuters) – A Virginia debt collection company has agreed to pay $24 million over allegedly illegal practices, the top U.S. agency for consumer financial protection said on Thursday, adding that the company had violated a previous order.

Rohit Chopra, director of the Consumer Financial Protection Bureau, said Portfolio Recovery Associates had been “caught red handed” in 2015, but had persisted in “intimidation, deception and illegal … tactics” to collect on unsubstantiated and undocumented consumer debt in recent years.

“CFPB orders are not suggestions, and companies cannot ignore them simply because they are large or dominant in the market,” Chopra added. Portfolio Recovery Associates said it had admitted to no wrongdoing.

In 2015 the CFPB ordered Portfolio Recovery Associates to cease collecting on debts without reasonable basis, selling debt, or threatening to sue or suing when it had no intent to prove the claims. The company agreed to pay $27 million to resolve the allegations.

The CFPB on Thursday said the company broke a number of provisions related to that order. The $24 million payment agreement includes a fine, as well as repayment to consumers harmed, pending court approval.

In a statement, Portfolio Recovery Associates said it was committed to dealing fairly and respectfully with its clients.

“Although we have admitted to no wrongdoing as part of the resolution, and we continue to disagree with the CFPB’s characterization of our conduct, we are pleased to have this matter resolved and behind us,” Kevin Stevenson, president and chief executive of parent company PRA Group Inc (PRAA.O), said in a statement.

Source : https://www.reuters.com/business/finance/us-watchdog-orders-virginia-debt-collector-pay-24-mln-illegal-practices-2023-03-23/

The U.S. House of Representatives has passed HR 7735, Improving Access to the VA Home Loan Benefit Act of 2022, a measure that would direct the U.S. Department of Veterans Affairs (VA) to update their regulations on appraisals. They would be required to consider when an appraisal is not necessary, and when a desktop appraisal should be utilized.

Introduced by Rep. Mike Bost of Illinois, HR 7735 would enhance VA’s home loan program by streamlining the home buying process for veterans and their families. HR 7735 would ease the home buying process by allowing the nation’s veterans to use the same modern purchaser tools that non-veteran buyers already use.

The VA home loan program has afforded millions of servicemembers, veterans, and their families the opportunity to become homeowners, a benefit that has empowered U.S. veterans with the resources they need to purchase, retain, and adapt homes at a competitive interest rate, and helps to ease the transition from active duty to civilian life. While VA’s home loan program has historically performed well and assisted many nationwide in achieving homeownership, it has not kept pace with today’s homebuying practices in certain ways. Veterans using a VA home loan are required to have an in-person appraisal performed by a VA-approved appraiser prior to purchasing their home. However, there are often lengthy wait times for the relatively few VA-approved appraisers to become available to perform these appraisals, resulting in in veterans being forced to wait longer to complete the homebuying process, and move into their new home.

“The bill will encourage important reforms to the agency’s requirements regarding when an appraisal is necessary, how appraisals are conducted, and who is eligible to conduct an appraisal,” said Bob Broeksmit, CMB, President and CEO of the Mortgage Bankers Association (MBA). “This legislation is an important first step towards broad modernization of VA appraisal processes and could make veterans’ home purchase offers more viable in today’s competitive housing market.”

Now that HR 7735 has passed the house, its companion bill in the Senate, S4208, the Improving Access to the VA Home Loan Act of 2022, introduced in May 2022 by Sen. Dan Sullivan of Alaska awaits passage.

“VA home loans have given millions of veterans and their families the opportunity to purchase a home,” said Rep. Bost. “Yet, on average, veterans wait longer and pay more during the closing process due to VA’s out-of-date appraisal requirements. That’s why I am introducing the Improving Access to the VA Home Loan Act of 2022 with my friend, Senator Sullivan. This bill will make sure that veterans are not unfairly disadvantaged during the home buying process and allow for a modern, digital appraisal process, which will get them into their new home faster.”

Source:https://themreport.com/daily-dose/09-15-2022/house-passes-bill-modernize-va-appraisals

Things Are About to Get Even More Interesting For Rates

It’s certainly already been an interesting year for financial markets–especially for housing and interest rates. But most of what’s happened over the past 8 months could be thought of as the more predictable phase of the post-pandemic market cycle. It’s what happens next that’ll be more interesting.

How could anyone say that the last 8 months have been predictable when rates have risen at the fastest pace in decades to the highest levels in more than 14 years? It’s true, the pace and the outright levels defied most predictions. But the predictable phenomenon was more of a general truth that we knew we’d contend with in late 2021. Here it is in a nutshell:

The Fed shifted gears on bond buying in late 2021, announcing a gradual wind-down of new bond purchases to be followed by a series of rate hikes. This shift from the Fed was always likely to coincide with rising rates and lower stock prices. The only uncertainty was the size, speed, and staying power of the shift as the Fed attempted to strike a balance between combatting inflation without crippling the economy.

See Rates from Lenders in Your Area

June’s reading of the Consumer Price Index (CPI, a key government inflation report) was the only major curve ball of the year–generally thought to be a byproduct of the Ukraine War’s effect on commodities prices.  It made for a rapid reassessment of the Fed’s rate hike outlook as seen in the chart below.

The blue line is the market’s expectation of the Fed Funds Rate after the September meeting.  Note the big leap in June.  To be fair, July’s inflation report caused another jump, but it fell back quickly to the previous 2.875% range and has been there ever since.  

Longer term rate expectations (for the December meeting as well as next June’s meeting) have had more ebbs and flows due to the shift in the economic outlook.  Weaker economy = lower long-term rates, all other things being equal.  These longer-term expectations share more similarities with longer-term rates like those for mortgages.

Rates recovered nicely in July as markets feared recession, but rebounded sharply in August as data suggested a much more resilient economy.  This was especially true of the jobs report in early August as well as the ISM Purchasing Managers Indices (PMIs) which are like more timely, more highly regarded versions of GDP broken out by manufacturing and non-manufacturing sectors.  

PMI data has been responsible for several noticeable jumps toward higher rates over the past month.  The same was true this week when the non-manufacturing (or simply “services”) version came out on Tuesday morning. The services PMI was expected to move DOWN to 55.1, but instead moved UP to 56.9, effectively keeping it in “strong” historical territory whereas the market thought it was trending back down to the “moderate” level.

That’s all just a fancy way of saying that, despite GDP numbers being in negative territory, and despite aggressive Fed rate hikes, other economic indicators suggest the economy continues to expand.  The PMI data helped push US rates higher at a faster pace than overseas rates as US traders returned from the 3-day weekend, but European rates took the lead on Thursday after the European Central Bank hiked rates and warned about upside risks to the inflation outlook.

While US economic data is certainly responsible for a good amount of upward pressure in rates recently, Europe and European Central Bank policies have been adding fuel to the fire.  This can be seen in the faster rise in EU bond yields. Incidentally, the initial jump in the blue line (US 10yr) in early August coincided with several strong economic reports in the US: ISM PMIs and the Jobs Report.

Long story short, rates have topped out twice and the market knows what it looks like to see high rates in conjunction with a strong economy.  The bigger question is the extent to which inflation is calming down.  After all, inflation is the reason the Fed continues to say it’s willing to attempt to restrain economic activity via rate hikes.  Looking at the year-over-year chart, it looks like we have a long way to go for the Fed to get core inflation back down to its target.

But year-over-year data is just that.  It includes the past 12 months–many of which contribute a massive amount to a total that will inevitably be much smaller even if the economy simply maintains the current monthly pace of inflation.  In fact, core inflation only needs to move down 0.1% in the next report to put year-over-year numbers on pace to hit the target range.  Once the Fed is reasonably sure that’s happening, it can begin to consider a friendlier shift in the monetary policy that has recently put so much upward pressure on rates.

And that brings us to why things are about to get interesting.  Summer is unofficially over.  School is back in session.  Traders are back at their desks.  And next week brings the next installment of the CPI data.  6 short business days later, we’ll get the next Fed policy announcement as well as an updated rate hike projection from each Fed member.

All of the above is made all the more interesting due to the fact that the Fed–by its own admission–has no idea how much it will hike rates in 2 weeks, and that it will only be able to decide after it sees economic data.  Given that CPI is by far and away the most relevant piece of economic data between now and then AND that the Fed has a policy of abstaining from public comment starting 11 days before a meeting (aka today was the last day of Fed comments until 9/21), the market’s reaction to next Tuesday’s CPI data could be tremendously interesting indeed. 

Source:https://www.mortgagenewsdaily.com/markets/mortgage-rates-09102022

Fair Lending compliance is a hot button issue, making it critically important that your institution has a clear sense of its fair lending risk exposure.

From the Office of the Comptroller of the Currency’s (OCC) supervisory priorities and speeches from officials at the National Credit Union Administration (NCUA) to the Consumer Financial Protection Bureau’s (CFPB) advisory on the Equal Credit Opportunity Act (ECOA) and the Justice Department’s fair lending initiative, all eyes are on fair lending.

While Fair Lending compliance can be complex, having a clearer sense of your risk exposure can make it simpler.

Uncovering fair lending risk to build a stronger fair lending program

The first thing to remember is that Fair Lending covers every stage of the crediting process — from marketing all the way to servicing.

Second, Fair Lending applies to all loans — not just HMDA loans.

And third, regardless of whether staff is officially responsible for compliance efforts, they are still responsible for supporting Fair Lending efforts and complying with Fair Lending laws and regulations.

Here are the seven primary Fair Lending risks.

Compliance Management Program Risk

Is your Fair Lending Compliance Management Program (CMP) able to effectively manage and mitigate your Fair Lending risk? The strength of your CMP needs to be commensurate with the inherent risk profile of your institution.

Redlining Risk

Redlining continues to be a major regulatory hot topic. But do you know your Redlining risk? In today’s regulatory environment, you need to.

Marketing Risk

Fair Lending extends to marketing. Financial institutions need to ensure they are marketing their services equally to similarly situated individuals. One question to consider as you assess your marketing risk is: Are we receiving applications consistent with our market demographics?

Steering Risk

As you assess steering risk, you will be looking to determine if similarly situated individuals are treated similarly. Any evaluation of steering risk will benefit from the insight provided by Fair Lending data analysis. One question to consider: Are we directing certain applicants to particular products? By analyzing your data, you’ll be able to identify any disparities.

Underwriting Risk

Underwriting risk is key area of Fair Lending risk. When analyzing your data, pay attention to the number and rate of originations and denials. As you assess your risk, look for any vague or subjective underwriting criteria or other potential for discretion in the process.

Pricing Risk

Are all similarly situated applicants receiving similar pricing? If not, you may have pricing risk exposure. As you analyze your data, you’ll be looking for incidence of rate spread, and disparities in the pricing charged. 

Servicing Risk

Consumer complaints are common during servicing, and consumer complaints can trigger regulatory attention. In analyzing your servicing risk, ensure that similarly situated individuals are being treated consistently. You’ll also want to pay attention to any disparities in loss mitigation servicing options, decision processing times, and collections processes. And be advised — even if your bank outsources servicing, you are still responsible for that third party vendor’s Fair Lending compliance.

Fair Lending is a top priority for regulators and regulatory scrutiny of Fair Lending will heighten. 

Are you aware of the Fair Lending risk in your financial institution?

Source:https://www.ncontracts.com/nsight-blog/7-fair-lending-risks-you-need-to-know-right-now

Underwriters are presented with 1,500 loans marked as “fraudulent” and they have to find the one that is genuinely fraudulent — a near impossible task.

KEY TAKEAWAYS

a) Repetition bias happens when mortgage underwriters have to wade through thousands of applications that have been marked as fraudulent by automated machinery — most of which are not actually fraudulent.

b) Lenders typically flag 40% of loans that come in with at least one fraud flag to review, so underwriters are essentially left in charge of finding a needle in a haystack.

c) This issue will only become more exacerbated as we enter a tighter housing market in 2022; applicants are more likely to fudge their income or their credit score to get their loan approved.

d) As the mortgage industry consolidates and layoffs begin, there may be fewer underwriters and analysts in the industry to sift through all these loans marked as fraudulent.

In the housing bubble era, fraud was running rampant all across the mortgage industry and the entire economy suffered the consequences. 

In the run-up of the crisis, underwriters facilitated wide-scale fraud by knowingly misreporting key loan characteristics, according to Griffin’s analysis. Credit rating agencies inflated their ratings on both mortgage-backed securities and collateralized debt obligations (CDOs), while originators also engaged in mortgage fraud to increase market share, and appraisers would inflate appraisals in order to gain business. 

The industry changed drastically after the financial crisis and with the creation of the Dodd-Frank Act. Entities and mortgage professionals are concerned about protecting themselves from fraud. Today, many are wary of fraud and fraudulent applications, which could end up costing their companies a pretty penny. But the industry is still struggling to establish an efficient system for identifying fraudulent loans. 

Point Predictive Chief Strategist Frank McKenna said that while mortgage lenders have implemented additional tools to identify mortgage fraud, problems related to mortgage applications are increasing at an alarming rate due to “repetition bias”, often causing hundreds of thousands in losses.

Repetition bias happens when mortgage underwriters have to wade through thousands of applications that have been marked as fraudulent by automated machinery. In some cases, the rate is 1,000 non-fraudulent applications (marked as fraudulent) for one truly fraudulent application. Repetition Bias creeps in when underwriters are quickly scanning and approving applications that were marked as fraudulent and they miss that one genuinely fraudulent application. Even one fraudulent mortgage that is approved can cost lenders hundreds of thousands of dollars.

A fraudulent application occurs when a borrower lies about their credibility and financial status by either fudging their income, credit score, or anything that might make them look more trustworthy. Today’s lenders use various approaches for identifying these fraudulent loans, mainly with automated machinery, but most of these systems are not smart enough to accurately analyze applicants.

“Lenders flag 40% of loans with at least one fraud flag to review,” McKenna said, “and sometimes much more than that. So, underwriters are essentially left in charge of finding a needle in a haystack.” 

An overwhelming amount of loans are being flagged as fraudulent and these all need to be reviewed by underwriters or fraud analysts. After reviewing a hundred or so applicants and finding out they are all non fraudulent, it creates a false-positive bias. However, this makes underwriters and analysts more susceptible to missing genuinely fraudulent loans. 

For example, applications can be flagged as fraudulent because the listed social security number (SSN) is also associated with other names; yet, only 1 in every 750 applications flagged with this are genuinely fraudulent. Oftentimes, the SSN appears on other applications with different addresses, but only one out of every 1,000 is actually fraudulent. Even more often, the SSN is randomized issued after 2011, though, only one out of every 1,500 of these are fraudulent applications. 

“It has the exact opposite effect of what a lender would want,” McKenna said. “You think by presenting more flags means you’ll catch more fraud, but actually the reverse is true. You create a bias towards the fact there’s no fraud.”

The amount in losses lenders could potentially face from accepting fraudulent loans is going to vary based on the lender’s portfolio, and lenders don’t typically release their fraud loss numbers, whether they’re public or private. However, McKenna estimates that slightly less than 1% of all mortgage originations are fraudulent. 

“I think the estimates that are done by industry experts indicate that fraud probably runs about 80 basis points so if you were to take the mortgage originations…” McKenna said, trying to calculate a rough estimate in his head, “I think about 80 basis points is kind of the standard calculation, so if there’s $2.6 trillion in originations it’s a very big number.”

McKenna believes this issue will only become more exacerbated as we enter a tighter housing market in 2022 where refinances have dried out and purchase originations are in. As it becomes harder to purchase a home — with bidding wars, rising prices, low inventory, and higher rates — applicants are more likely to fudge their income or their credit score to get their loan approved.

“With refinances, you’ve been in the house and have been paying their mortgage,” McKenna explained. “In tighter markets, which are typically purchase markets, there is more risk involved — especially with first-time home buyers.”

“You have a lot more people in the industry who need to keep making money, [brokers, lenders, …etc] so they want to get creative on how to close deals,” McKenna continued. “So that also plays a huge factor in increasing the risk of fraud.” 

As the mortgage industry consolidates and layoffs begin, there may be fewer underwriters and analysts in the industry to sift through all these loans marked as fraudulent. However, McKenna presents an alternative mechanism that is more selective and precise when it comes to identifying fraud. 

Point Predictive’s Mortgage Pass reduces false positives by 65% or more over current solutions. Mortgage Pass is a machine-learning AI that’s taught much in the same way that a human learns, where it’s shown lots of examples of fraud and lots of examples of non-fraud to differentiate. 

“It’s able to differentiate when a pattern exists on a problem that doesn’t exist on a good loan,” McKenna said. “So it is a version of artificial intelligence because it’s being trained with lots of data.”

“I wouldn’t recommend lenders discard any processes they currently do,” McKenna added, “but they can layer this process over what they do.”

Currently, much of the burden and responsibility for identifying fraud falls on underwriters that are already understaffed. 

“Layoffs in the mortgage industry are going to happen,” McKenna said. “So mortgage lenders are gonna be looking at ways to reduce costs. They’re going to have to kind of look at reducing false positives as part of that cost reduction.” 

Source:https://nationalmortgageprofessional.com/news/repetition-bias-leads-increased-mortgage-fraud?utm_source=National+Mortgage+Professional&utm_campaign=ed7a5d97c3-EMAIL_CAMPAIGN_2022_03_03_07_03&utm_medium=email&utm_term=0_4a91388747-ed7a5d97c3-71467005

Fannie and Freddie tighten condo-lending rules. Details vary, but they generally won’t back single-unit condo loans if a building has deferred maintenance issues.

ORLANDO, Fla. – In response to the Surfside tragedy, Freddie Mac announced last week that it would immediately start taking a closer look at a condo development’s maintenance issues before approving individual loans. The change follows a similar announcement made earlier by Fannie Mae. The two mortgage giants back over half of all U.S. loans.

The new requirements can be complex – Freddie Mac posted its announcement online – but they will generally deny condo and co-op unit loans if the building has deferred maintenance issues, special assessments to fix deferred issues or other problems.

All changes announced in Freddie Mac’s bulletin “will be effective for Mortgages with Settlement Dates on or after Feb. 28, 2022.” Fannie Mae’s earlier bulletin says its rules will be “effective for whole loans purchased on or after Jan. 1, 2022, and for loans delivered into MBS pools with issue dates on or after Jan. 1, 2022.”

Both policies “remain in effect until further notice.”

As part of the process, Fannie Mae lenders will send condo managers a five-page form that must be completely filled out. Under the section that covers insurance types and amounts, it even includes instructions, such as “Do NOT enter ‘contact agent.’” The regulations apply to all condominiums with five or more units, even if that complex is otherwise exempt from review.

While individual condo buyers may immediately face hurdles getting a loan approved, the tighter policies could have a longer-term impact on entire condominium complexes. Even condo associations without concerning maintenance issues could find that unit owners – without the backing of Fannie Mae and Freddie Mac – will have a harder time selling their property if the new paperwork isn’t filled out correctly and returned promptly.

“Loans secured by units in condo and co-op projects with significant deferred maintenance or in projects that have received a directive from a regulatory authority or inspection agency to make repairs due to unsafe conditions are not eligible for purchase,” Fannie Mae states in its Oct. 13 announcement. And those projects “will remain ineligible until the required repairs have been made and documented.”

Fannie Mae considers acceptable documentation to be “a satisfactory engineering or inspection report, certificate of occupancy, or other substantially similar documentation that shows the repairs have been completed in a manner that resolves the building’s safety, soundness, structural integrity, or habitability concerns.”

While Fannie Mae and Freddie Mac’s changes apply nationwide, Florida may feel a greater impact due to the number of condo buildings across the state.

In addition, condo complexes that have deferred maintenance issues or one of the other problems noted won’t be approved for Fannie Mae- or Freddie Mac-backed loans until those issues have been fixed.

Source:https://www.floridarealtors.org/news-media/news-articles/2021/12/new-lending-rules-threaten-some-condo-sales

NCUA issued a Regulatory Alert (21-RA-11) with the 2022 annual adjustments for three exemption thresholds under the Truth in Lending Act (TILA or Regulation Z) and the Consumer Leasing Act (CLA or Regulation M). The thresholds exempt loans from special appraisal requirements for higher-priced mortgage loans and determine exempt consumer credit and lease transactions under Regulation Z and Regulation M.

The 2022 thresholds, effective on Jan. 1, 2022, are an increase from the 2021 thresholds.

The CFPB also issued an annual adjustment to the maximum amount credit bureaus may charge consumers for making a file disclosure to a consumer under the Fair Credit Reporting Act (FCRA or Regulation V). The 2022 ceiling, effective on Jan. 1, will increase from the 2021 ceiling.

1 ) The appraisals for higher-priced mortgage loans exemption threshold for 2022 will increase to $28,500 from $27,200 based on the annual increase in the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W) in effect as of June 1, 2021.

2) The consumer credit and consumer lease exemption threshold for 2022 will increase to $61,000 from $58,300 based on the annual percentage increase in the CPI-W in effect as of June 1, 2021.

3) The credit bureau consumer report fee maximum allowable charges for 2022 will increase to $13.50 from $13.00, based proportionally on changes in the Consumer Price Index for all urban consumers. The ceiling does not affect the amount a credit union may charge its members or potential members, directly or indirectly, for obtaining a credit report in the normal course of business. Such cost is expected to be accurately represented in all advertising, disclosures, or agreements, whether presented orally or in written form.

Source:https://news.cuna.org/articles/120322-compliance-2022-thresholds-for-regulations-z-m-v