Originating a home loan imposes a degree of risk on the lender, the stakes of which are made all the worse by Fannie Mae’s and Freddie Mac’s (collectively Frannie’s) strict punishment for underwriting flaws. If a lender makes a mistake on the loan documents it submits to Frannie, the lender is forced to repurchase the loan from Frannie, a process they call a put-back. These mistakes include misrepresenting (intentionally or unintentionally) the home’s appraised value or the homeowner’s creditworthiness.
This repurchase rule is essentially a put option included in standard agreements between lenders and Frannie. When exercised by Frannie it is to the lender’s detriment – a backwards strategy. Frannie is supposed to be taking on the lender’s risk when they purchase the loan, not the other way around.
However, a “secondary wave” of repurchases is now underway, demanded by Frannie on loans they now reject but purchased from big mortgage lenders who in turn obtained the flawed loans from other banks.
A former chief credit officer of Freddie Mac has suggested Frannie charge lenders who have made a certain amount of underwriting flaws an additional fee to guarantee their mortgages, rather than require them to buy back flawed loans.
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Frannie has yet another management problem (they are owned by the U.S. Treasury (Treasury)), recalling Freddie Mac’s bet earlier this year against homeowners refinancing into lower rates.
One of the main difficulties when a homeowner attempts to refinance an underwater home is the result of Frannie’s buy-back rule.
Lenders avoid refinancing home loans with high loan-to-value (LTV) ratios they do not service due to the high risk associated with submitting new documentation to Frannie. Lenders do not want to be stuck with an underwater mortgage if a homeowner misrepresented information on their refinancing application or the lender made a mistake.
By dissuading lenders from helping underwater homeowners refinance, Frannie is harming itself (and the Treasury and taxpayers by extension), as homeowners unable to refinance into low rates and reduced payments default. While charging a fee in place of demanding buy-backs is one way to encourage lenders to participate in the refinancing of underwater homeowners with high cost loans, lenders of course will pass that fee along to the borrower. Still, bad loans will be refinanced as a result.
Thus, homeowners suffer and pay either way, and lenders remain sloppy. Instead, we should address the underlying problem – lenders with insufficient and untrained staff to process home loans and refinances. Inadequate staff results in avoidable mistakes, as occurred in the recent robo-signing catastrophe evidenced in the national mortgage settlement. Why should homeowners (and taxpayers) have to continue to pay for this lender defect too?
Re: Mortgage Putbacks Must Change, Former Freddie Credit Chief Says from Bloomberg Businessweek