By Gerard Glavey
Data and document validation is more critical today than it’s ever been. Scrutiny by Fannie Mae and Freddie Mac is increasing as quality control timelines are shifting to earlier after loan purchase, reviews are becoming more comprehensive, and targeted sampling of loans based on risk attributes is expanding. Freddie Mac’s Industry Letter on Quality Control and Enforcement Practices and their publication on Quality Control Best Practices provide the requirements for designing, administering and documenting an effective quality control program. Fannie Mae’s Loan Quality Initiative (LQI) and recent policy changes to Fannie Mae’s Selling Guide have specified new additional requirements related to the frequency, depth and timeliness of loan quality reporting.
The Department of Housing and Urban Development (HUD) outlines its Quality Control Plan requirements in Chapter 7 of the 4060.1 Handbook. This states, “All FHA approved mortgagees, including loan correspondents, must implement and continuously have in place a Quality Control Plan for the origination and/or servicing of insured mortgages as a condition of receiving and maintaining FHA approval.”
In addition, HUD recently announced a new proposed plan that would require FHA lenders to provide compensation for the “estimated total risk” to the agency’s insurance fund based on a statistical sampling that would then be extrapolated across the Lender’s FHA portfolio. This is not surprising considering that a sample reviewed by the FHA in the first quarter revealed that just 19% of loans were deemed acceptable, meaning they had no mistakes. Given these findings, now is the time for mortgage lenders to get a handle on loan quality and have QC procedures in place that can lower “estimated total risk” for FHA lending.
Bottom line, the implementation and management of a Quality Control program is now a given. The following is a summary of HUD, Fannie Mae and Freddie Mac initiatives focused on the importance of an effective Quality Control Program.
HUD’s QUALITY CONTROL INITIATIVE:
All FHA approved lenders must not only have a Quality Control (QC) Plan in place to review loans that are originated or underwritten, but they must provide a copy of the plan when applying for mortgage approval. Each lender’s QC Plan must meet specific requirements and provide details as outlined by HUD/FHA in Chapter 7 of HUD Handbook 4060.1.
- The QC Plan must be in writing.
- The QC function must be independent of the lender’s originating and servicing functions.
- Reviews must be within 90 days from the end of the month that the loan closed.
- Reviews must be conducted at least monthly for lenders closing more than 15 loans per month
- The sample size of loans reviewed must be 10% of loans or a statistical random sampling that provides a 95% confidence level with a 2% precision for lenders that originate more than 3,500 FHA loans per year.
- Loans targeted for review should include loans from all Branch Offices and should reflect work from each Loan Processor, Loan Officer, Underwriters, etc., as well as each FHA loan program such as 203(b), 203(k), HECM, etc). Also included should be Early Payment Defaults (all loans going into default within 6 months), rejected loan applications (minimum of 10%) and Compliance Issues (i.e. RESPA, Fair Housing, Ineligible Participants check, HMDA, handling of escrow funds, MIP payments, advertizing, etc.).
In addition to these requirements, quality control reviews must also address lenders use of Third Party Originators. At least 10% of loans originated and sold to them by their TPOs must be given a QC review. If there are less than 10 loans, at least one of them should be QC reviewed. ALL early payment defaults (loans that go into default within 6 months) must be reviewed within 45 days from the end of the month that the loan is reported as 60 days past due. Review results must be documented, the methodology used to target must be in writing and any corrective actions taken as a result of the review findings must be included.
The disposition of loans originated is also a consideration for quality reviews. Lenders must perform a QC review on rejected loan applications within 90 days from the end of the month in which the decision was made to deny the loan (requirements for targeting are outlined in para. 7-8 (a) of the HUD Handbook 4060.1, REV-2). For the sales and transfer of loans, HUD mandates that a lender’s QC Plan include a requirement to ensure the review of all Mortgage Change Records for accuracy and perform a data integrity check of the information reported to HUD via the FHA Connection.
Regarding findings of fraud and material deficiencies, lenders must immediately notify HUD via the Neighborhood Watch Early Warning System and report management’s response and corrective actions for each.
In HUD’s Condominium Project Approval and Processing Guide, it is stated that lenders must select for QC review a minimum of 10% of all project approval reviews completed by staff reviewers (para. 4-3). The selection must be representative of all of their staff reviewers (those registered on Condominium Staff Reviewer’s Registry for Direct Endorsement Lender Review and Approval Process (DELRAP) reviews) and include project approvals as well as denials. Each lender is accountable for the quality of the reviews performed by their staff and HUD monitors the quantity and quality of condo project reviews completed.
FANNIE MAE’s “LOAN QUALITY INITIATIVE” (LQI)
As outlined on the www.efanniemae.com website, the main components of the Loan Quality Initiative (LQI) are: policy updates to require more loan data, the Uniform Mortgage Data Program, support tools such as Early Check and a new series QC measures throughout the delivery process. In addition, Fannie Mae’s recent Selling Guide Announcement (SEL-2013-05) includes new policies and changes/clarifications to existing policies that require categorization of defects by severity levels, reporting on the results of both prefunding and post-closing reviews to senior management on no less than a monthly basis, and lender review of at least 10% of the loans reviewed by vendors, to name a few.
An effective quality control program will help lenders identify and remediate loan-level issues that can reduce the risk of repurchases. Each lender’s Quality Control Plan should outline the expectations of the lender in terms of loan quality, anticipated default rates and what is considered to be acceptable risk, with on-going monitoring against these standards.
Fannie Mae’s Early Check service enables lenders to access delivery data checks at all stages in the loan origination process. Potential eligibility and/or data issues can be identified and corrected prior to loan delivery. This is important since Fannie Mae will check DU data at the time of loan delivery. In this regard, the last DU submission must match the loan delivery data. Some data fields cannot contain any errors while others have set tolerances.
Pre-funding reviews are an important aspect of a lender’s overall QC plan. Fannie Mae allows such reviews to be performed outside of the lender’s Quality Control Department, and should operate independently of the lender’s production, or at a minimum by someone independent of the decision on the loan being reviewed. Such reviews are utilized to validate the integrity of the loan information and to identify any additional training needs. The results of these reviews should be recorded along with the plans of action taken to address any concerns.
Post-closing QC reviews, including rebuttals, must be completed within 120 days from the month of the loan closing. Upon request by Fannie Mae, QC audits and the audits of the QC process must be provided. When conducting the reverification of the borrower’s credit history, lenders must include a new tri-merged credit report in all cases.
Audits of a lender’s Quality Control policies and procedures should be conducted from time-to-time with the objective to determine if the Firm’s QC policies are being followed, that reports which are generated are being delivered to the designated management officials and, after receipt, that appropriate actions (if any) are being taken to adequately address any deficiencies identified as a result of the audit. These audits can be outsourced by the lender (there certainly are advantages in doing so) and should be scheduled in such a way to ensure that the QC plan is adequate and effective. For example, a large volume lender with higher instances of data integrity problems and defaulted loans would need to schedule more frequent audits than a smaller lender with few data errors and a better tract record on defaults.
Additional information on Fannie Mae’s Quality Control Process and Lender Quality Control Requirements can be found in Fannie Mae’s Lender Letter LL-2012-05 and Announcement SEL-2013-05.
FREDDIE MAC’S “THE POWER OF QUALITY”
On the www.freddiemac.com website, guidance is provided to lenders in how to strengthen their loan manufacturing process and focus on increasing loan quality. Quality Control is certainly a key component of this loan manufacturing process.
Freddie Mac expects lenders to have a Quality Control Program with processes and controls that support compliance with their loan purchase requirements. It is stated that a lender’s “in-house QC program must have written procedures, operate independently of the origination and underwriting functions, include re-verification and/or re-underwriting processes, regularly monitor the overall quality of mortgage production and employ effective sampling and reporting procedures”.
Every seller/servicer is subject to quality control review of mortgages sold to Freddie Mac. Enhanced sampling and review efforts supported by technology and data gathering tools provide timely and meaningful information on lender’s loan quality. Random and targeting sampling and analysis of loan-level data will continue to be refined based on loan quality and ongoing industry changes.
Freddie Mac also encourages lenders to utilize the services of a third party QC provider in carrying out their QC Plan. If the services of such a Firm are utilized, however, it is recommended that the lender monitor & evaluate the performance of this Firm on a regular basis. Also, it is essential that the Third Party QC Firm have access to all of the lender’s contracts with Freddie Mac & be provided training when any substantive policy changes are made.
The QC requirements for Sellers to Freddie Mac are outlined in Chapters 46 & 48 of their Single-Family Seller/Servicer Guide. Pre-closing QC reviews play an integral part of the overall QC program. As stated in this Guide, “the goal of an effective pre-closing review process is to monitor the Seller’s origination policies, ensure accuracy of the mortgage data and prevent the closing of mortgages with deficiencies such as fraud, inaccurate data and insufficient documentation”. The type of data validated or reverified during a pre-closing review include: data integrity checks of the data entered into Loan Prospector, SSNs, appraisal data, mortgage insurance coverage, etc.
On their website, Freddie Mac highlights some industry Best Practices with respect to QC Plans. This resource guide includes recommendations such as:
- Use of a combination of both pre and post closing QC reviews with targeted and random sampling on a monthly basis.
- Initiation of re-verifications as soon as possible after the monthly sample of cases is selected.
- Designation of one individual in the Firm to be the QC Representative – this person should not be responsible for any mortgage origination, processing or underwriting functions.
- Making revisions to the QC Plan as needed (i.e. programmatic changes, investor requirements).
- Incorporation of controls or reviews that promote fair lending principles, etc.
- File reports on quality control reviews in a timely manner (Freddie Mac requires a report within 90 days of selection of the files for review), distribute to proper management officials, recommend corrective actions and provide tracking & trending results.
- Use feedback obtained from quality control reviews to improve training programs for staff involved in the loan manufacturing process.
Freddie Mac has created a Quality Control Review Documentation Checklist to ensure that lenders have included all required loan documentation for the borrower in the loan file.
COMMON ASPECTS OF QUALITY CONTROL PROGRAMS
The key common criteria outlined by HUD, Fannie Mae and Freddie Mac for an effective Quality Control Plan include the following: a lender’s QC Department should be separate from mortgage origination and underwriting, the QC plan should be in writing and reports that are generated are delivered in a timely manner to senior management staff with recommended corrective actions. Conducting pre and post funding reviews is recommended by Fannie Mae and Freddie Mac as part of a lender’s monthly sampling of cases to be reviewed and data integrity checks throughout the loan process are essential. Training should be conducted to address any weaknesses uncovered as a result of a lender’s QC reviews. The utilization of third party QC Firms that conduct reviews and prepare reports to track and trend underwriting deficiencies is highly recommended.
LoanLogics was founded to improve the transparency and accuracy of the mortgage process and improve the quality of loans. Our products and services can help lenders comply with the quality control guidelines as set forth by FNMA, FHLMC, FHA and VA. With the industry’s first Enterprise Loan Quality and Performance Analytics Platform we serve the needs of residential mortgage lenders, servicers, insurers, and investors that want to improve loan quality, performance and reliability throughout the loan lifecycle. Our advanced solutions help clients validate compliance, improve profitability, and manage risk during the manufacture, sale and servicing of loan assets. Our technology is supported by compliance and risk expertise that aligns with our customers’ need to address their own highly regulated environments.
For additional information, visit our website at www.loanlogics.com or contact us at 866-557-6959.