Why lenders are wary of FHA's terms for buying loans with forbearance

Lenders are concerned about a risk requirement imposed by a recent Federal Housing Administration measure aimed at opening up homeownership opportunities that might otherwise be threatened by coronavirus-related developments.

The FHA is temporarily willing to insure mortgages that go into forbearance due to COVID-19 hardships. But in exchange, lenders must agree to be on the hook for 20% of the original loan value if those mortgages go into foreclosure in the next couple of years.

Therein lies the rub, according to a letter sent to the FHA by several housing industry trade groups on Wednesday.

The move may not open the market up much if providing that indemnification discourages mortgage companies from taking on the risk and funding loans, according to the letter, which was sent in response to the agency's request for feedback. As a result, they're calling for the obligation to be removed.

"The excessive indemnification requirements in ML 2020-16 will effectively force lenders to impose higher credit and financial overlays to protect against risks that they cannot control during the underwriting process," a coalition of business, consumer and minority trade groups said in the letter.

"We have seen a similar response to the GSEs' recent policy to charge steep loan level price adjustments, and to stop purchasing certain refinance loans altogether, if a borrower seeks forbearance after closing but prior to delivery," the groups added.

But in some ways the stakes are higher for mortgages insured by the FHA than for single-family loans purchased by the government-sponsored enterprises.

Under the terms of the coronavirus rescue package, both types of loans have been allotted forbearance upon request for up to a year if borrowers have a coronavirus-related hardship. While forbearances appear to be leveling off, there is concern that new loan performance problems could emerge in the future.

And FHA loans generally serve a lower-income and more financially vulnerable population than home mortgages purchased by the government-sponsored enterprises do. The share of loans with forbearance in mortgage-backed securities Ginnie Mae insures, many of which are FHA loans, is much higher than it is in the GSE conforming loan market.

"These overlays will severely limit access to FHA-insured financing for the borrowers who need it the most, disproportionately impacting low- and moderate-income families, first-time homebuyers and borrowers of color," the trade groups said.

Among the housing industry signatories to the letter are the National Association of Realtors, the Mortgage Bankers Association and the National Association Home Builders. Other examples of organizations that signed the letter include the nonprofit Center for Responsible Lending and minority trade groups like the National Association of Real Estate Brokers and the National Association of Hispanic Real Estate Professionals.

The letter acknowledges that the indemnification is aimed at addressing financial risks from the coronavirus that everyone involved is affected by and trying to mitigate.

Specifically, the FHA wanted to address heightened risk that distressed loans will hurt the finances of its mortgage insurance fund in the event that forbearance fails to prevent broader loan performance issues.

"While we understand FHA's desire to limit risk and exposure during uncertain times, we believe the resulting burden on the lender will have the effect of severely limiting access to FHA-insured loans for homebuyers," the trade groups said in their letter.