As part of its continuing efforts to protect and strengthen the Federal Housing Administration insured mortgage program, the U.S. Department of Housing and Urban Development has published a final rule on lender requirements to indemnify HUD for FHA insurance claims, and the basis upon which a lender’s Lender Insurance approval may be terminated.

Published in the January 25, 2012, Federal Register, the final rule is a revised version of the proposed rule published in October 2010.

In the proposed rule, HUD had requested comment on whether lenders should be required to submit case binders electronically, but the agency did not adopt that requirement and now advises that it will continue to consider the issue. The final rule takes effect on February 24, 2012.

Indemnification

An FHA lender with Direct Endorsement authority can apply for Lender Insurance approval, which permits the lender to originate an FHA-insured mortgage loan without submitting pre-insurance review documents to FHA. (More than 80 percent of forward FHA insured mortgage loans are originated by lenders with Lender Insurance approval.)

Under the National Housing Act, HUD can require a lender that originated an FHA insured mortgage loan using its Lender Insurance approval to indemnify HUD for an insurance claim paid within a "reasonable period," as determined by HUD, if the loan was not originated in compliance with HUD requirements for FHA loans. However, under the Act there is no time limit imposed on HUD’s seeking indemnification when there is fraud or misrepresentation involved in the origination of a loan. Current HUD regulations simply refer to the statutory indemnification obligation without providing any guidance or parameters.

For situations not involving fraud or misrepresentation, the final rule establishes as the "reasonable period" for indemnification a period of five years from the date the loan was endorsed for mortgage insurance. HUD may require indemnification if "the mortgagee knew or should have known of a serious and material violation of FHA origination requirements, such that the mortgage loan should not have been approved or endorsed by the mortgagee." Significantly, the indemnification obligation applies regardless of whether the violation caused the mortgage default.

To provide guidance on what may cause the requisite "serious and material violation of FHA origination requirements," the final rule includes non-exhaustive examples of when such a violation might occur. Examples are if the mortgagee fails to:

  • Verify the creditworthiness, income, and/or employment of the mortgagor in accordance with FHA requirements
  • Verify the assets brought by the mortgagor for payment of the required down payment and/or closing costs in accordance with FHA requirements
  • Address property deficiencies identified in the appraisal affecting the health and safety of the occupants or the structural integrity of the property in accordance with FHA requirements
  • Ensure that the appraisal of the property serving as security for the mortgage loan satisfies FHA appraisal requirements

The final rule also provides for the indemnification of HUD for an insurance claim by a lender if the lender knew or should have known that fraud or misrepresentation was involved in connection with the origination of the loan. There is no time limit on when indemnification may be required, and there is no requirement that the fraud or misrepresentation be the cause of the default.

Termination of Lender Insurance Authority

Under current rules, to obtain Lender Insurance approval the claim and default rate of a lender must be at or below 150 percent of the national average for all insured mortgages for at least two years prior to the application for approval. A lender that operates in a single state may elect to have its claim and default rate compared with the average rate for that state. Additionally, once approved, HUD monitors the eligibility of a lender to participate in Lender Insurance program on a yearly basis.

The final rule provides that to obtain Lender Insurance approval, a lender must maintain a claim and default rate that is at or below 150 percent of the average rate for insured mortgages in the state or states in which the lender operates for at least two years prior to the application for approval. Loans with a beginning amortization date that falls within the two-year period are considered for purposes of computing the claim and default rate.

It also addresses how the requirement for a two-year acceptable claim and default rate may be met in cases of a merger, acquisition, or reorganization. The final rule expressly provides that a lender must maintain a claim and default rate at or below the 150 percent level to maintain is Lender Insurance approval, and that HUD will monitor a lender’s eligibility to participate in the Lender Insurance program on an "ongoing basis." HUD had proposed to monitor eligibility on a "continual basis," but changed the wording in the final rule to conform with an existing HUD rule regarding its Credit Watch Termination Initiative.

Apparently HUD does not consider this to be a substantive change, as it uses the words "continual" and "ongoing" to refer to the basis of monitoring in the supplementary information to the final rule. HUD declined to provide further guidance in the final rule on the specific manner in which the claim and default rate will be calculated, despite requests by commenters that it do so.

A lender that has its Lender Insurance approval terminated may reapply for the approval. The lender must wait at least six months from the termination of the approval, satisfy the requirements for initial approval, and also submit a corrective action plan addressing the issues resulting in the termination, along with evidence that the lender has implemented the plan.

The termination of a lender’s Lender Insurance approval does not terminate the ability of the lender to seek FHA insurance for loans under the pre-insurance submission process.

Ballard Spahr’s Mortgage Banking Group combines broad regulatory experience with formidable skill in litigation. Clients include financial institutions; mortgage lenders, brokers, and servicers; secondary-market investors; insurance companies; investment bankers; settlement service providers; auction platforms; and homebuilders. Members of the group edited and authored Mortgage Finance Regulation Answer Book 2011-12. For more information, please contact one of the Practice Leaders of the Mortgage Banking Group: Richard J. Andreano, Jr., 202.661.2271 or andreanor@ballardspahr.com; or John D. Socknat, 202.661.2253 or socknatj@ballardspahr.com.

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