Prevent the Dreaded Loan Buyback

Jan 2, 2024

Safeguard your origination business by following prefunding best practices

By Pamela Hamrick

Picture this: An independent mortgage bank (IMB) that makes 100 loans per month is gradually and strategically emerging from the industry downturn. The lender has diversified its products and services, automated its previously clunky processes and hired some star loan officers.All is moving in the right direction until 10 unexpected loan buyback requests come in from Fannie Mae, costing a total of $1 million. The impetus for the repurchases are loan defects that were never caught during the prefunding stage of the fulfillment process.

“The process can be akin to roaming every thread of a spiderweb to find defects, but it’s worth it to take careful steps.”

Lenders always face some risks of buybacks, but Fannie Mae’s recent tightening of its prefunding quality control requirements is designed to prevent these types of scenarios. A lender must now conduct prefunding reviews on 10% of its closed loans or up to 750 loans per month (whichever is the lesser number).

This is a significant change for mortgage originators, who were not previously required to audit a set number of loans prior to funding — steps that can add unwanted time to the processing cycle. Fannie Mae took action after observing a sizable increase in eligibility violations for loans acquired during the year ending in April 2021. These violations frequently fell into key defect categories such as incorrect income calculations, the borrower’s unemployment status and undisclosed liabilities.

Detailed review

A prefunding quality control review is an audit that is completed on a sample of loans prior to closing, thus ensuring they’re free from defects. As part of the process, originators must document their review procedures and address four aspects — timing, loan selection, verification of data and documents, and reporting.

If they choose, lenders can complete a combination of full-file reviews and component reviews. In the latter case, quality control will focus on specific areas of a loan that pose a unique or elevated risk, such as a high loan-to-value (LTV) or debt-to-income (DTI) ratio.

 “Lenders should also be diligent about post-funding reviews, since Fannie Mae has imposed additional guardrails there too.”

Moreover, lenders must conduct reviews independently of their production department whenever possible. The people who complete these tasks cannot be involved in processing or underwriting decisions. The lender should design a plan to identify and address defects before a closing takes place. And they should allow adequate time to select loans, review them and communicate changes to production personnel.

According to Fannie Mae’s Selling Guide, lenders should target areas where a higher risk of fraud, mistakes or misrepresentation exist. These may include loans with complex income calculations (commonly involving self-employed borrowers or those who derive income from rental property); loans with multiple layers of credit risk (such as high LTV or DTI ratios); and loans secured by properties in areas that have high delinquency rates or are currently experiencing rapid changes in real estate values.

Strategic value

Fannie Mae and Freddie Mac have up to three years after buying a loan to request a repurchase, and each buyback can result in an average estimated loss of $100,000. Meeting agency requirements should help lenders avoid losses when they least expect them.

In today’s market, lenders are struggling to stay profitable and simply cannot afford this. Indeed, according to a survey from the Mortgage Bankers Association, IMBs and mortgage subsidiaries of chartered banks had an average pretax net loss of $1,015 on each loan originated in third-quarter 2023 alone.

The safeguards that quality control reviews incorporate are intended to keep such losses to a minimum. The process can be akin to roaming every thread of a spiderweb to find defects, but it’s worth it to take careful steps.

Quality control isn’t just about weeding out errors to protect lenders. It’s also a strategic process of turning data into insights. This will help the lender solidify its market position while maximizing its financial performance through improved revenues, profits, customer service and brand reputation.

Through targeted samples of loans prior to funding, for instance, operational leaders might discover that an originator has been steadily increasing their percentage of high-LTV loans. This could lead to a much-needed update of the company’s underwriting guidelines to manage balance-sheet risk and help prevent future losses.

The lender also might discover that newer loan officers are repeating the same mistakes, indicating a need for additional training or supervision. Linking the purpose of quality control to these broader outcomes is pivotal to a lender’s continued growth and vibrancy.

Read the rest of the article at Scotsman Guide