4000.1 Revisions Making Your Teeth and Hair Hurt?

Please be calm - the changes are mostly cosmetic

As we reported earlier, there should be no real surprises in the 9/14/2015 4000.1 release. The only area that seemed to cause some alarm related to the pre-closing audit rigor. If you are a Quality Control Plan customer of ours, you know that we have ALWAYS recommended this as a standard process.

Then you have to parse the guidance to understand the percentages, To reiterate:

10% of all production gets audited
10% of all AUDITS must be pre-closing/in-process audited

If you originate 100 loans, you must audit 10 (in addition to ensuring that you capture all sources in an audit cycle). Of that 10, 1 may be a pre-closing/in-process random audit. It seems like chicken and egg, but you have to look back at your total audit percentages to make the determination that you have conducted enough pre-closing/in-process audits.

Here is a sample policy that addresses 4000.1 Requirements for your QC Plan.

1-19-1 QC HUD 4000.1 Requirements

The requirements listed in Quality Control Plan requirements are referenced below as to how we comply in our procedures.

In general, the 9/14/2016 Update to the HUD/FHA Single Family Handbook re-organized standards into a new format referred to as the 4000.1 Revision. Although HUD’s requirements for quality control did not change substantively, the new policy manual opens QC reviews to a broader definition, by referring the examiner back to the Underwriting or Delivery requirements. Single elements no longer get addressed as minutiae, rather the entire guide is incorporated by reference.

A reiteration of HUD/FHA QC Review Area. This shows with some clarity that the scope and scale of "In-Process/Pre-Closing Review" is the same as the Post-Closing Review.

1-19-2 Referrals for Elements Specified in HUD 4000.1

We have located specific elements queried by examiners in the QC Plan for ease of reference.

4000.1 Section	Requirement	Location in QC Plan
A.3.a iv(A)	Sampling Methodology	1-22 QC DEL – Loan Selection Methodology and 1-23 QC DEL - Loan Sampling/Selection Procedure
A.3.a i(A)	Pre-closing reviews	1-20-1 In-Process Quality Control Audit 1-40 QC DEL – In Process Loan Level Quality Control Review Process
A.3.a i(C)	Early Payment Default (EPD) reviews	1-22-2 Early Payment Default

1-19-21 Terminology – Pre-Funding, Pre-Closing and In-Process Reviews

Please note that terminology may vary with all of the variation between industry standards regarding the Pre-Closing, Pre-Funding and In-Process reviews.

The terminology is so close as to cause confusion among lenders and reviewers.

·         Pre-Funding reviews refer to the review of Loan Quality Initiative and similar fraud detection elements conducted on EVERY loan before it closes.

·         Pre-Closing/In-Process reviews refer to the concealed selection of individual loans in process to identify potential fraud within the production process.

·         10% of ALL audited loans should be sampled. Example: If you fund 100 loans, 10 total loans should be audited and 1 should be pre-closing audited.

·         Loans PRE-CLOSING AUDITED do NOT have to be re-audited post-closing and count toward the 10% of ALL LOANS audited.

·         The ONLY DIFFERENCE between the pre-closing and post-closing audit is that the reviewer does NOT HAVE TO WAIT for re-verifications to come in. We still request third party verifications, but we do not have to wait to close the loan.

·         Post-Closing Audit is the full scope audit conducted by lenders and delegated correspondents. 

Unlike Pre-Closing/In-Process Audits, Post-Closing Audits MUST WAIT for Third Party Verifications before completing review.

MortgageManuals.com customers may download the update here.  If your numeration doesn't match the items shown here, you have missed the past updates and need to request a complete update

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)

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

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.

Consistency

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.

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:

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.  

OBSERVATION

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.

RECOMMENDATION

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.

11/19 - Conforming Limits to Remain Unchanged

Maximum Conforming Loan Limits to Remain Unchanged in the First Nine Months of 2011

FROM HUD - New Mortgagee Letter Clarifying Eligibility

Mortgagee Eligibility Requirements and Clarification of FHA’s Electronic Annual Certification Requirements and Procedures 11/19 - http://www.hud.gov/offices/adm/hudclips/letters/mortgagee/