FHA Proposal Aims to Clarify Loan Rules

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The Federal Housing Administration released guidelines to clarify requirements for lenders, a move meant to increase mortgage access but that could also make it more difficult for the government to recover damages when lenders make mistakes.

The FHA is one of the primary avenues through which first-time home buyers get loans. The agency sells borrower-paid insurance to back mortgages with down payments of as little as 3.5% with credit scores of as low as 580.

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However lately, some lenders said they fear being sued for making mistakes on loans that later default. As a result, they have put in place extra requirements, known as "overlays," that could preclude loans to borrowers with a score below 640.

"We want real clarity and specificity on what lenders are responsible for," said Edward Golding, who heads the FHA, adding, "clearly, we think it is one step in getting more lenders comfortable with removing overlays."

For now, when lenders make an FHA mortgage, they must certify that the loan has no errors. When mistakes have been found, the Justice Department has sometimes pursued damages under the False Claims Act, a Civil War-era law that lets the government recover triple damages.

That has led to some lawsuits and settlements that some banks said have driven them away from making loans under the FHA program. Last year, the Justice Department reached a $614 million settlement with J.P. Morgan Chase & Co., leading the bank to pull back from the program.

More recently, Detroit-based Quicken Loans Inc., now one of the biggest FHA lenders, in April sued the government, alleging that the Justice Department was trying to force it to settle for fraud it didn't commit.

Less than a week later, the Justice Department sued Quicken, in part saying the mortgage company made loans to borrowers it knew couldn't pay.

Last Friday, the FHA released for comment modifications to the certification that lenders must make when making an FHA-backed loan.

The changes appeared in the Federal Register, a government publication that issues proposed and final government regulations. However, the FHA, which is part of the Department of Housing and Urban Development, didn't immediately inform lenders or other stakeholders that it had been released.

A HUD spokesman said the agency plans to begin outreach to lenders on Friday. Stakeholders have about two months to provide input on the changes before the FHA releases the final version. The spokesman said the proposed changes require lenders to promise to follow specific requirements in the FHA's guidelines rather than "certifying to somewhat broad, vague language."

Under current rules, lenders could face a severe penalty if they misstate a borrower's income by just $1. Under the proposed requirements, that wouldn't be the case, HUD said.

David Stevens, president of the Mortgage Bankers Association which lobbies on behalf of lenders, said it isn't clear whether or not the changes as proposed could lead to looser credit requirements for low-down-payment loans.

The change "could be extraordinarily impactful, but if it's too vague or leaves too much uncertainty it's not likely to have the effect that HUD officials want to see."

Quicken Loans said the changes didn't go far enough.

In a statement, Quicken said the modifications were minor. "These changes do nothing to address the true problems that have beset the FHA program. The increasingly vague, arbitrary and unreliable rules of doing business with the FHA have forced nearly every major lender to dramatically reduce (or cease completely) its government insured lending."

A Justice Department spokeswoman declined to comment.

In February, when The Wall Street Journal reported that discussions on changing the certifications were taking place, the spokeswoman said, "The False Claims Act restores scarce funds stolen from vital government programs and deters those who knowingly would misuse public funds. The Justice Department will continue to pursue all manners of financial fraud."

(By Joe Light)