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   ARTICLE   |   From Scotsman Guide Residential Edition   |   July 2018

The GSEs Are Spreading Their Wings

The FHA loan program faces increasing competition from the big boys on the block


The news is replete with stories about rising rates, low home inventories and rising home prices. All of these factors have contributed to an affordability crunch for many Americans looking to purchase their first home or hoping to move up to a larger home in a better neighborhood. Low-downpayment options, allowances for heavier debt loads as well as limited or weaker credit profiles are additional hurdles stifling these would-be buyers. 

To address this problem, the government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac have been making calculated moves to dive into the realm of what traditionally has been the market space of the Federal Housing Administration (FHA). Both GSEs have rolled out new programs, updated technologies and shown a general loosening in credit policies over the last few years so they can capture more business.

The GSEs are allowing higher loan-to-value ratios, offering cheaper private mortgage insurance options and giving lenders tools intended to streamline and speed up the loan process. These shifting market trends should matter to mortgage originators looking to provide their clients with the best financing options, given the GSEs and FHA are key market players that are ultimately competing for that business.

Expanding GSE reach

Historically speaking, prior to the collapse of the subprime market a decade ago, FHA’s share of the mortgage market was normally about 10 percent per year. In the years that followed the financial collapse, FHA’s share swelled to almost 19 percent. As conditions improved over the past several years, the GSE’s have taken back some of that market share, and FHA’s share of the mortgage-origination market currently stands at about 13 percent.

The differences between GSE and FHA loan types are narrowing as the GSEs delve deeper into areas they previously avoided.

Many experts feel this trend will continue as the GSEs push forward, looking at new ways to be better, all while FHA seems to be stagnant, with little to no momentum in terms of making advancements or reducing the cost of their mortgage insurance premiums. There also is a perception among some home sellers that a purchaser using FHA is not as attractive as a purchaser using a conventional loan. 

The perception is that FHA loans take too long to close and that the buyer may not be as financially strong as someone who is approved for conventional financing. The GSEs know all of this, so they have been revamping their products and services to copy some of what FHA has been doing. Their end game is to assist people in achieving homeownership while also gaining market share they did not possess previously.

Lower insurance costs

Not that long ago, it was a lot easier to look at a borrower’s profile and place them into the specific loan type that best suited their particular needs. Those lines are more blurred in these current times, as the differences between conventional and government loans are starting to blur. Take, for example, maximum allowable loan-to-value ratios (LTVs).

For years, FHA was the go-to loan for people with limited downpayments, given most people could figure out a way to come up with the FHA-required 3.5 percent down by saving it over time, getting a gift from a relative or using some type of downpayment-assistance program. Coming up with the required down on a conventional loan, often 20 percent, proved a bit more challenging. 

To address this, both Fannie Mae and Freddie Mac announced in December 2014 they were upping the maximum allowable LTV to 97 percent. It was a move in the right direction because now highly qualified borrowers with limited cash assets had a way to purchase a home and avoid having to pay FHA’s costly upfront mortgage insurance premium, in addition to having life-of-loan monthly mortgage insurance tacked onto their payment. By getting a conventional loan with a high LTV, it meant less money was needed for a downpayment and closing costs, and if the home appreciates, the borrower may be able to cancel the mortgage insurance (MI) at some point in the future. 

In addition to increased LTV offerings, the GSEs also offer reduced MI cost options. For loans with a reduced MI option, the required coverage for a mortgage with an LTV greater than 95 percent, for example, is as low as 18 percent (while the standard is 35 percent). This cost savings compares nicely to the FHA monthly MI when you factor in all of the pros and cons. The private mortgage insurers also have been lending a helping hand to the GSEs in their quest to compete against FHA by offering lower MI premiums. One large private mortgage insurer recently announced that they were passing along the lower corporate tax rates that were signed into the new tax law and incorporating that tax benefit into their borrower-paid premiums. 

There also are reports of insurers giving preferred premium pricing on mortgage insurance to specific lenders behind the scenes, and you are seeing lenders offer a no-MI option loan. While moves such as these open the door to more limited-downpayment borrowers qualifying, the strategy was truly designed to generate more business for Freddie and Fannie. 

Loosening the strings

The GSEs also have made several credit-policy changes in recent years, an indication that they are loosening their standards to be more competitive. Borrowers with heavier debt loads, those with debt-to-income (DTI) ratios above 45 percent, for example, benefit most from the changes. 

The FHA standard has been to approve ratios up-ward of 55 percent for certain risk profiles. Fannie Mae’s automated underwriting standard was capped at 45 percent, and Freddie would approve loans with DTIs up to 50 percent in certain cases. Still, the GSEs DTI standards were restrictive, and many qualified borrowers were forced into FHA loans specifically because of the amount of debt they carried, even if their credit profiles were strong. 

To address this, last year Fannie Mae announced changes to how its Desktop Underwriter (DU) would look at DTI ratios of up to 50 percent. It removed the requirement that certain additional compensating factors had to be present in order to approve a borrower with a DTI ratio between 45 percent and 50 percent.

This loosening is just one example of the GSEs’ willingness to compete for more business. They realized that they were missing out on a tangible amount of mortgages opportunities involving highly credit-qualified borrowers whose DTIs hovered in the 45 percent to 50 percent range. 

Improving the technology

On the technology side, both GSEs have made major improvements and rolled out new automated underwriting systems for their lender partners. Freddie replaced Loan Prospector with its revamped Loan Product Advisor. It was redesigned to enhance the readability of the feedback messages and has a much better look and functionality than the prior system. Freddie touts the upgrade as the cornerstone of a suite of tools designed to make mortgage processing simpler and more efficient.

Fannie Mae also has been at the forefront of advancements with its roll out of Collateral Underwriter (CU) and Day 1 Certainty. The CU enhancement allows greater clarity with respect to home valuation and the reliability of value opinions and appraisal quality. 

The data being collecting by Fannie from electronic appraisals has been integrated with its automated underwriting system, Desktop Underwriter (DU) That integration, in certain cases, allows lenders the option of utilizing a property-inspection waiver if DU accepts the value that was provided at submission. This means quicker turn times, as there is no appraisal required, plus that results in significant cost savings for the borrower. 

Day 1 Certainty, on the other hand, validates employment, income and assets. This means the borrower will not have to provide income and asset documentation, and the lender is relieved of some of the reps and warrants when they deliver the file. The Day 1 system will make a 12-day escrow a reality. While it is still new technology, it’s definitely a precursor to what the future of a truly automated mortgage industry will look like. Freddie Mac also has automated collateral validation, and an automated asset- and income-validation system is in the development stages and will be released in the near future. 

The FHA, on the other hand, still relies on Total Score-card, which hasn’t had any major updates and relies heavily on feedback messaging derived from the Department of Housing and Urban Development’s underwriting guidelines. While there are some reduced documentation requirements with an FHA automated approval, compared to manually underwritten loans, those efficiencies fall short of the level of reduced documentation the GSEs require on their automated approvals.

Competition offers choices

When there is competition among the GSEs and FHA, this benefits the public as a whole because it fosters more options and more affordable loan terms, which ultimately allows more people to qualify for home loans. There will still be situations where an FHA loan is the better choice, but the differences between GSE and FHA loan types are narrowing as the GSEs delve deeper into areas they previously avoided.

For homebuyers with above-average credit, a conventional loan with a 3 percent downpayment may be a better choice, especially if using Freddie’s Home Possible or Fannie’s HomeReady mortgage programs with reduced MI options and no up-front mortgage insurance. The FHA loan is no longer the only low-downpayment choice for borrowers, given there may now be less costly alternatives in many circumstances. 

A true consultant-type originator should always look at all loan types and not just go with the path of least resistance. It could ultimately give the borrower a better loan, reduced costs, quicker turn times and a better chance of a purchase-offer acceptance.


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