Wednesday, July 31, 2013

Learning to Love Appendix Q - Ability to Repay Part 2

Inside the Box - It's a tight fit...

In Part 1 we talked about the benefits of Appendix Q, how having clear guidelines on how to make loans and what was acceptable for Qualified Mortgages might be a good thing.  When you dive into Appendix Q, which is the regulation that codifies those underwriting guidelines into law, you start to see the box of loans that might get approved as QMs getting smaller.  At the same time, some ambiguities still exist that a smart loan officer, processor or underwriter might use to help a borrower stretch.

Ability to Repay Cheat Sheet (QuickNotes)

This is a one page version of the 172 pages of qualified mortgage ability to repay for mortgage compliance training purposes
Download and review the cheat sheet and use it to discuss the regulations
with your staff.  Download the ABILITY TO REPAY study guide.

We have included our first draft one-pager to GoogleDocs for you to download and comment on.

Our intent is to try and take some of this massive regulation and cook it down into a manageable piece of information.  This sort of contraction works to allow us all to see the larger picture.  It does contain some shorthand for mortgage professionals, but we act in brevity in order to not waste time on flowery details.  There's plenty of time for flowery details in the CE Class.

More than anything, we want to start to look at tools we can use to work with this data  in a way that helps loan originators help customers qualify for a loan.  This is, after all, what the rule was designed to assist with.

Notable Omissions and Questions

When you review the actual text of the rule, it is clear that it has been cribbed from FHA guidelines.  They state this within the regulation, but in reviewing it clearly have failed to completely edit it, including references to "endorsement" when establishing time frames.  Obviously, this doesn't apply to the mortgage industry in general but only to direct endorsement loans.

Other references come from someone's dated recollection of the products in the mortgage marketplace.  For instance, there are multiple references to the "Two Step" loan, which Appendix Q defines as a loan with an interest rate that changes on a fixed schedule.  This was a hybrid product in the 80's, but I haven't seen a Two Step, the way it is defined within Appendix Q, since then.  The more recent definition of the Two Step was the ARM alternative to the balloon, which was fixed for 5 or 7 years, and then permanently modified to a fixed rate.  But this is not what Appendix Q refers to.

When calculating net rental income from the subject property, one area states "use the 25% vacancy factor" when another area specifies you cannot use income from a rental property when it is the subject property.

Income Quandaries in Appendix Q

The biggest trouble spot deals with variable and self-employment income, where conservative underwriting seeks to exclude any risk without defining situations that may be beneficial for the borrower.  On the pro- side, shorter than 2 years self-employment is allowed under certain circumstances.  However, Appendix Q does not specify how much a borrower's income can vary when you have declining income in an averaging scenario.  Declining income, in any situation, makes the loan ineligible.

In addition, self-employed borrowers must be compared to other similar businesses in the area.  If the other businesses are in decline the loan is ineligible.

Residual Income?  Still Not Defined

Ratios and residual income are referred to synonymously, but there is no qualification rubric for anything except for the 43% total debt ratio.  This is a hopeful sign, in that the use of a residual income computation mechanism can be applied in lieu of a ratio when circumstances dictate.  

We will examine residual income and asset depletion models in our next Appendix Q Issue - Learning to Love Appendix Q - Calculating Residual Income Methods

Thursday, July 25, 2013

Banker v Broker: Future of the Broker Business is its Past

We Are In the Same Business - Why the Divide?

In the conversations, news, editorials and blogs I follow I see a real philosophical divide between brokers and bankers. It grows more pronounced as rates rise and the regulatory dust settles revealing all the implications of the new rules.  Bankers (correspondent lenders and banks) have a derisive view of brokers that seems to spring from a perception of unethical marketing practices.  Brokers feel that bankers have an unfair regulatory advantage with respect to compensation.  As expected, the position you take on these issues depends where you sit.

Sample mortgage broker advertisement from the Willmar Tribune, circa 1895
Advertisement in the Willmar Tribune
November 18, 1895

The Future of Mortgage Brokering

To contemplate "survival" or the "future of the mortgage broker" you must have a clear understanding of the roles these distinct business models play in the marketplace.  Before there were institutional mortgage lenders who arranged financing by selling securities into the capital markets, banks, sellers and private lenders provided  the sources for home financing.  This financing often carried draconian terms; call provisions, short term balloons, and rarely extended more than 5 years.  If your property was mortgaged, you had considerable worry about your ability to renegotiate at maturity, or whether the bank or seller would demand payment unexpectedly.  To deal with these exigencies there was the mortgage broker, "mortgage agent" or "loan agent."

The sources for loans - banks, insurance companies, private lenders - weren't always easy to locate.  These institutions also didn't necessarily have the capacity or desire to deal with the consumer.  If the institution did go directly to the consumer, just as is true today, the borrower didn't have the expertise to negotiate and query loan terms to identify a good deal. The market need for someone to play the role of mortgage broker - an intermediary between lenders and customers - demonstrated itself in the media of the time.

What Value Does the Mortgage Broker Add? - A Marketplace of Transparent Terms and Customer Choice

Beyond simply facilitating the loan process, brokers should add value by seeking out products not necessarily available in a particular market.  As the advertisement in the Willmar Tribune (Nov 12, 1895) shows, the loan agent proves value by showing the customer that there are multiple programs available from many different lenders; the broker brings new products to market.

In addition, the broker allows the customer to comparison shop the available terms.  The unspoken advantage for the customer dealing with the loan agent here is that IT'S THE BANK that is likely to take advantage of you, so you should work with a broker who will be transparent. How DID THIS get turned around?  Today the popular perception is that it's the broker who is dishonest.  Clearly, this is where today's brokers have fallen furthest in delivering their value to the marketplace.  Undisclosed fees, lack of process transparency, bait and switch loan offers all have contributed to this perception.  Sadly, some of the outcry over unfair regulation stems from a desire to hold on to these less than transparent practices which, frankly, provoke understandable suspicion.

Advertisement from
the front page of the Dodge City Times - 4/18/1888
In the post-Civil War reconstruction period (1865-1885) credit demand grew, spawned by economic growth and investment.  In these excerpts you see images and methodologies that are not that different from the solicitations you see today.

The creation of the government guaranteed mortgage and FNMA in the 1930's changed that, heralding the entry of a new business model - the mortgage banker - who competed with the banks to provide this financing.  The first S&L crisis (when rates went to 18%, driving S&Ls with portfolios of 4% mortgages into insolvency) exposed the value of the mortgage banker's business model, selling fixed rate securities and passing interest rate risk on to the long-term investor.  But the mortgage bankers are not really lenders.  They are "proxy-lenders" who can make loans intended for resale on a delegated basis.

The Value-Added Service for Mortgage Bankers and Correspondents

Technically, the mortgage banker provides the same value as the mortgage broker, in terms of transparency: to be competitive with a set of proxy products, you have have to have a sharp price.  In the secondary market where these proxy loans are sold, the pricing moves second by second and an entire year of marginal gains in loan sales can be wiped out in one bad day.  For this reason, a mortgage banker's true cost - total net price when considering origination fees, points, servicing premiums and net warehouse interest margin - is irrelevant at the loan level. Some days you are ahead, and some days you are behind.  Then there are expenses that you cannot quantify at the loan level:  deficiencies, buybacks, insurance and hedging costs. The only true measure of your profitability is your ability to offer products in a relatively similar band as other proxy lenders.  With this risk, why do mortgage bankers even want to be in this business?

The answer lies in the production of loan servicing and servicing rights.  If a lender has the right to collect 0.375% - 0.50% annually on its portfolio of serviced loans, then the company can have long term viability regardless of the origination climate.  $1 Billion in mortgages can generate $3.75 million in cash flow, which can support operations when originations start to flag.

The advantage the mortgage banker provides - in addition to a sharp price competitive with other proxy lenders - is the ability to control a transparent process.  Lenders control the underwriting and funding process internally, whereas brokers have to rely on their correspondents for service delivery.  Technically speaking, a mortgage banker should never lose the service delivery competition (who can close the loan faster?) to the mortgage broker.

Two Completely Different Business Models - There IS No Competition

If both business models adhere to their market derived functions, no conflict should ever exist between broker and mortgage banker.  In fact, there should be an easy symbiosis:  brokers should refer borrowers who are ideal proxy lender candidates to the proxy lenders - lenders should refer borrowers who need a variety of products outside the proxy lender's range to the broker.

Conflict only arises when the lender tries to act as a broker or the broker tries to act as lender.

In the early '00's many mortgage bankers used the secondary market to create a fictitious price-for-risk model allowing them to place outside the-box exceptions and sub-prime borrowers.  This was not "proxy lending" as clearly defined by the guidelines in place, but was a manipulation of the due diligence cycle for short term gains.  We all understand this now.  As these loans came into wide distribution in 2005 and 2006, institutional investors began to push back as the poor loan quality was revealed.  American Home Mortgage, the largest proxy lender at the time, literally collapsed in May of 2007 within 2 months of the completion of the quality control cycle.  The remainder of the story we have all lived through.  This short term manipulation of the due diligence cycle signaled lenders acting as brokers: trying to provide a market solution that didn't exist.  Brokers, on the other hand, have been placing hard to qualify, credit impaired borrowers as a market defined business model.

On the other side, brokers capitulated to the proxy lender's behavior.  Brokers began to represent themselves as "lenders" and "correspondents" using faux processes such as table-funding to create the illusion that the customer was dealing with a proxy-lender.  Brokers used this illusion to justify inflating or concealing their origination fee income to the customer, while holding themselves out to customers as offering the "best price."  While the principle of "buyer beware" should guide a consumer to vigorously validate market terms, customers do not possess the broker's expertise.  When brokers act as lenders they abrogate their market role, which is to provide a transparent alternative to proxy lenders and product alternatives to bank lenders.

The 2007-09 contraction in the broker business, where 90% of brokers closed or went to work at banks or mortgage bankers, simply reflected this abrogation of duties.  Brokers acting as lenders cannot subsist long term.  It is a capitalist paradigm that your business model must follow its optimality. In times of high refinancing activity it may appear possible because the broker provides the excess origination capacity that proxy lenders cannot afford to invest in.

To survive in the future brokers should look at the business model's successful past.  Seek out products that are not widely available through lenders. Provide service niches. When providing proxy-lender products such as conforming loans, prepare to offer them at the sharpest possible price.  "Be true to yourself" is a life aphorism for success.  Brokers should not focus on their unnatural existence of the past 10 years, but on the future and innovating to meet the challenges of higher rates, tighter guidelines and regulation.  Brokers were a force 150 years ago, long before the proxy-lenders existed.  In a world of GSE reform, they may survive past them, too, if they are true to themselves.

Tuesday, July 23, 2013

Learning to love Appendix Q - Part 1

For those of us who have prided ourselves in our knowledge and ability to navigate borrower qualification guidelines  the advent of the Qualified Mortgage and Ability to Repay provisions known as Appendix "Q" strike cold fear in our hearts.  We distinguish ourselves in our ability to fit a round peg in a square hole, working each nuance, arguing around the edges with underwriters, and find a way to get loans approved that others can't while still giving those borrowers the very best rates.  To us, the fact that these guidelines have now - for the first time in mortgage history - been codified into law represents the end of the utility of our long years of study to know every nook and cranny of lending rules.  But if we can look at it from another perspective, we can find some advantages to the black and white approach of the regulation.


We know too well how one underwriter allows certain elements, and another treats things differently.  While we can sometimes take advantage of these discrepancies, when a loan ends up in the wrong hands it can also create disruptions in your pipeline.  Remember your battles with the underwriter over what percentage of non-taxable income could be counted, or whether we could accept a borrower who had only been self-employed for a year?  Appendix Q removes the ambiguity of these circumstances and allows us to accept applications with less concern over eligibility.

Shortened Learning Curve

As a new loan officer you face the biggest hurdle in learning loan plan specifications for, potentially, hundreds of different investors.  In the past, we have shortened this hurdle by saying "learn FHA, Fannie and Freddie and VA, and then learn how the other programs are different."  Great!  But that was still  FOUR completely different sets of guidelines.  With appendix Q, a new loan officer must just learn ONE set of guidelines as a starting point to our origination career.

FHA Guideline Overview
Sample Loan Plan Specification

Finally, A Practical Continuing Education Application

How many times can we study RESPA, TIL and ECOA in our annual CE?  The addition of lending guidelines to the regulatory construct allows us to open the area to discussion in "for credit" education.   We study loan guidelines on a daily basis as a matter of course - now lets do it for CE credit!

A Starting Point - FHA

Our lesson, at the highest level starts with understanding FHA lending guidelines, since Appendix Q extracts underwriting guidelines from the HUD-4160.2

As we go through the process of understanding these guidelines more intimately we will try and assemble them into a concise collection of QuickNotes - easy reference tools for us all to compare to.  See the FHA Guidelines we have assembled here:

Thursday, July 18, 2013

E-SIGN Policy and Procedure - Free to Download and Comment

How do I Know That my Customer Actually Signed That Document?

Click here to access the E-SIGN Policy Template - Read, Review, Comment, Download - Be part of defining best practices.  

This is one of those pernicious questions.  How do you know?  For compliance managers, investors and regulators alike, the issue is fraught with peril.

FNMA has been ready for e-mortgages since 2007
While FNMA, FHLMC and other agencies have generally accepted and provided guidelines for E-SIGN for mortgages they purchase, they have combined to purchase a paltry number of completely electronic loans. In fact, the law states that E-Signatures are equally as valid as live signature.  The difficulty in implementing E-SIGN technology surrounds the fact that, since the signature itself is not present to persist in perpetuity, or as long as records must be retained, we must retain the entire architecture and underlying records of the E-SIGN technology in order for the e-signature to be completely valid.  Because of the difficulties with this, some of which may not yet be foreseen, many lenders persist in requiring live, or “wet”, signatures or a facsimile thereof.

The Electronic Signatures in Global and National Commerce Act (E-SIGN) was implemented in 2001, supplementing the Uniform Electronic Transactions Act (UETA).  Due primarily to difficulty in affirming electronic signatures for note and security instrument purposes, but also to the legacy of paper processing,  “wet”, or live, signatures continue in prevalent use.

Among the exhibits in the loan files, electronic facsimiles have become ubiquitously acceptable - credit reports, appraisals, income and asset documentation can all be accepted.  The last major barrier to embracing E-SIGN was the IRS' refusal to accept E-SIGN for tax transcripts (4506-T) required a live signature until January 2013.  With this impediment removed a groundswell of lenders have begun to accept fully electric files.

With this in mind, we need to complete the circle of our understanding of this part of the process:

1.)  How DO you know its your borrower?  Do you have a policy in place to ensure compliance?
2.)  What happens when a customer opts out of E-SIGN?  Which forms have to be re-signed?

There are many other questions and we should discuss them here.

For MortgageManuals customers you can download the template on our Updates and Downloads page

Wednesday, July 17, 2013

Response to HUD/FHA's Request for Comment on Quality Control Procedures - TAKE ACTION

FR–5723–N–01 Federal Housing Administration (FHA): Single Family Quality Assurance- Solicitation of Information on Quality Lending Practices

HUD has requested feedback from the industry on revisions it needs to make to its quality assurance process.  It is important to weigh in on this.  WE DO NOT WANT ANOTHER 4060.1 (REV 2)!  What we need is clarity on what FHA is finding that is causing problems so we can incorporate those issues into our current quality control plan.  WE DON'T WANT TO HAVE 2 or 3 DIFFERENT PLANS.  We want to have one plan that we can use to insure that our loans meet ALL guidelines.

PLEASE RESPOND TODAY that we need clarity, not a new bureaucracy.  Submit your response by copying and pasting the last paragraph of my response below.  If you don't act now, we will all pay the consequences.

July 17, 2013

As a participant in, and subsequently a consultant to, the mortgage lending industry I applaud FHA/HUD for taking this proactive approach to risk management through production quality control.  


The industry has made substantial strides in updating mortgage quality assurance standards.  Both FNMA and FHLMC issued detailed guidance communicating with real transparency their expectations for the level of review and the things that will cause a loan to be defective.  Their updates came at a time when the ability and appetite of the industry to absorb putbacks had evaporated.  Lenders no longer simply capitulated to indemnification demands but challenged them because of the opacity of the GSEs requirements. 

In our business we review the 4060.1 REV-2 to help prepare a lender for mortgagee approval.  The quality control measures prompted in the 4060.1 REV-2, when adhered to the letter, expose the lender to substantial risk of omission.  The guidelines show FHA's laser focus on a few narrow areas, and then silence on everything else.  Lenders who follow these quality guidelines to the letter will have defects: the requirements are too open-ended to provide real direction. 

For this reason, we insist lenders install a comprehensive "production quality control process" which includes peer quality control review of the application, processing, underwriting and closing for EVERY loan, in addition to hiring/management.  These functions are "re-reviewed" in the post-closing sampling.  This proactive checklist system can evolve if we discover additional findings.


PLEASE DO NOT create another 4060.1 REV-2 type manual.  FHA should disseminate a list of defects it has found on loans (like a FAQ) that lenders must use to screen their files pre-underwriting and pre-endorsement.  FHA should work to align its process requirements WITH industry best practices instead of a "special" track.  Change fatigue will impair adherence to "new" requirements."

A Comprehensive QC Checklist will go much further in improving loan quality
than another manual.
Our quality control plans include extensive editable checklists that allow your personnel to address potential loan quality issues BEFORE they become buybacks or declined loans.  Let's have a discussion of best practices to insure we are catching everything.

I have attached a sample of a comprehensive QC checklist for production.  (It is an older version, because the current version is one we sell - I don't want to cannibalize our product)  Please feel free to comment or talk to us directly about implementing a complete quality process.