To Be or Not to Be: FHA Loan Correspondents Face a Looming Question

Written by Weiner Brodsky Sidman Kider, PC Friday, 30 April 2010 19:24

Articles - Features

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On April 20, 2010, HUD rolled out new regulations continuing its FHA reform efforts in a rulemaking entitled, "Strengthening Risk Management Through Responsible FHA-Approved Lenders" (the "Final Rule"). As the name implies, the Final Rule, which becomes effective May 20, 2010, will cause a sea change in the regulations applying to Federal Housing Administration (FHA) insured mortgagees and, as a result of the FHA Home Equity Conversion Mortgage's (HECM) prominence in reverse mortgage lending, the processes, policies and procedures of all reverse mortgage originators and lenders. Among other matters, the Final Rule, (i) significantly increases net worth requirements for all approved mortgagees, (ii) eliminates an entire classification of FHA-approved entity (the loan correspondent), (iii) expressly authorizes certain non-FHA-approved entities to perform limited origination functions, (iv) charges FHA-approved lenders with the responsibility to assess the qualifications of third-party originators for participation in FHA loan transactions, and (v) changes the rules governing Principal-Agent relationships between FHA-approved entities.

Alas, with passage of the Final Rule, current FHA loan correspondents must answer an age-old question of Shakespearean proportions: “To be an FHA-approved lender, or Not to be an FHA-approved lender?” Whether it is nobler to suffer the slings and arrows of originating mortgages as a third-party originator, or to take arms against a sea of troubles in becoming approved as an FHA lender 1? Whether it is better to bear those ills we have, than fly to others that we know not of? As the Final Rule imposes its will upon us, this article will hopefully help you understand these changes and highlight some of the important decisions that HECM lenders and originators must soon make.

FHA-Approval for Loan Correspondents: No Longer Available

In a sweeping policy change, HUD has eliminated the approval process for loan correspondents. As of May 20, 2010, FHA will no longer issue separate approval for loan correspondents to participate in FHA programs. Instead, entities that wish to originate FHA-insured loans may do so as non-FHA-approved “third-party originators” (or “TPOs”) through FHA-approved lenders (i.e., “sponsors”). An entity may also choose to itself become an FHA-approved lender.

According to the Final Rule, non-FHA-approved mortgage brokers may originate FHA-insured loans as TPOs by working with FHA-approved lenders (sponsors). A TPO may originate and transfer an FHA-insured loan to its sponsor. The sponsor must underwrite the loan and submit the loan to FHA for insurance. The sponsor also must ensure that the TPOs legal name and Tax ID number appear in the FHA loan origination system record for the subject loan.

A TPO may not purchase or hold an FHA-insured loan. Also, a TPO may not close FHA-insured loans in its own name. Although this limitation is still being reviewed by HUD and might later be changed, as of the effective date of the Final Rule, an FHA-insured loan originated by a TPO must close in the name of the sponsoring FHA-approved lender.

Loan correspondents currently approved by FHA will retain their existing FHA approval and may continue to act as an FHA-approved loan correspondent through December 31, 2010. In addition, current FHA-approved loan correspondents may continue to have loans closed in their own name through December 31, 2010. However, beginning January 1, 2011, unless the loan correspondent itself becomes an FHA-approved lender, it may only originate FHA-insured loans as a TPO through an FHA-approved sponsor.

The Final Rule does not provide for an automatic transition of FHA loan correspondents to FHA-approved lenders. Loan correspondents that elect to become an FHA-approved lender must apply to FHA for approval as a mortgagee. Importantly, in order to become an FHA-approved lender, among other things, the loan correspondent must meet the increased FHA new worth requirements discussed below.

Currently approved loan correspondents will need to make a business decision whether to seek approval as an FHA-approved lender or forego FHA approval and become a TPO. As noted above, the Final Rule extends the existing FHA approval through December 31, 2010. FHA-approved loan correspondents should use this time to either apply for FHA-approved lender status or, if the entity elects to act as a TPO, confirm existing relationships with their sponsoring FHA-approved lenders and establish new sponsoring relationships.

Oversight of Third-Party Originators

Under the Final Rule, FHA-approved lenders must verify that the TPO is eligible to participate in the origination of FHA-insured loans. Among other things, the sponsoring mortgagee must verify that the TPO or the TPOs officers, partners, directors, principals, managers, supervisors, loan processors or loan originators have not been subject to an administrative action or sanctions that would disqualify them from the FHA program.

In addition, FHA-approved lenders are responsible for the actions of their sponsored TPOs. The Final Rule provides that FHA-approved lenders must ensure that the loans they fund originated by their TPOs meet all applicable FHA loan origination and processing requirements. FHA-approved lenders are subject to sanctions (e.g., civil money penalties) when their sponsored TPOs fail to comply with all FHA requirements.

Note that the requirement to supervise TPOs is not entirely new. HUD’s long-standing policy has been that FHA-approved lenders are responsible for the actions of their loan correspondents. In addition, FHA-approved lenders must comply with HUD’s existing quality control requirements. HUD’s quality control requirements are extensive and include the review of loan files originated by loan correspondents.

The Final Rule does not establish minimum requirements for TPO approval. However, the Preamble to the Final Rule provides several recommended measures that FHA-approved lenders should develop and implement if they plan to work with TPOs:

1. Procedures to verify TPO compliance with all federal, state, and local requirements that govern their activities;
2. Procedures to verify TPO compliance with the requirements of the SAFE Act;
3. Procedures to ensure that TPOs are not suspended, debarred, or under a limited denial of participation (LDP) in HUD’s Credit Alert Interactive Voice Response System, or on the Federal Government’s Excluded Parties list;
4. Institutional guidelines and systems for establishing and maintaining relationships with TPOs;
5. Procedures that govern the performance of due diligence;
6. Systems for monitoring loan quality and performance for each sponsored TPO;
7. Procedures for addressing potential problems with TPO operations, business practices, or customer service, and clearly articulated remedial processes for instances when such problems occur;
8. Enhanced quality control plans and procedures that ensure appropriate evaluation of TPO originations;
9. Ongoing renewal processes to ensure that TPOs continue to meet the lender’s approval standards; and
10. Procedures for evaluating the financial capacity of TPOs.

Importantly, a lender may not knowingly or willingly conduct business with a TPO that is not in compliance with FHA rules and all applicable laws and regulations. A lender that becomes aware of non-compliance by a TPO must cease sponsoring such TPO and immediately notify HUD.

HUD noted in the Preamble to the Final Rule that, because of FHA’s existing loan correspondent oversight requirements, the increased burden upon lenders that elect to sponsor non-FHA-approved mortgage brokers would be “minimal.” Given HUD’s list of recommended oversight measures for FHA-approved lenders, it seems at least the initial changes necessary to begin originating loans through TPOs may be significant for many lenders.

At a minimum, FHA-approved lenders must implement robust policies and procedures for approval, setup and supervision of mortgage brokers as TPOs. This includes the initial determination of TPO qualifications and monitoring the ongoing performance and financial capacity of the TPOs. Even lenders that already have policies and procedures in place for approval and oversight of loan correspondents will undoubtedly need to revise such existing policies and procedures to tailor them to their new relationship with TPOs. FHA-approved lenders will also need to revise their existing Quality Control Plan to take into account their new TPO relationships.

As noted above, lenders that have an existing relationship with FHA-approved loan correspondents may continue such relationships through December 31, 2010. This gives lenders some “breathing room” to implement broker setup and oversight policies and procedures, and to start entering into new relationships with TPOs.

It remains to be seen whether lenders will elect to continue to rely on existing relationships with loan correspondents through the end of the year, or will start sponsoring new mortgage brokers as TPOs prior to the end of the year. Of course, for the remainder of 2010, a lender might do both: sponsoring new TPOs after the effective date of the Final Rule (assuming it has implemented TPO setup and oversight policies and procedures), while continuing to do business with its existing loan correspondents. Commencing on January 1, 2011, a lender wishing to work with mortgage brokers may only do so by sponsoring them as TPOs.

Increase in Net Worth Requirements

Net Worth Requirements for Years 2010 and 2011

Under the Final Rule, effective on June 21, 2010, new applicants for FHA approval must have a net worth of not less than $1 million. At least 20 percent of such required net worth must be comprised of liquid assets consisting of cash or its equivalent, as may be acceptable to HUD.

Existing FHA-approved lenders (including both supervised and non-supervised mortgagees) must comply with these increased net worth requirements as of May 20, 2011. As such, while new applicants for FHA approval must comply with the increased FHA net worth requirements upon application, existing FHA-approved lenders are afforded a full year to comply.

Note, also, that existing FHA-approved lenders that meet the definition of a small business must have a net worth of not less than $500,000, of which no less than 20 percent must be liquid assets consisting of cash or its equivalent, as may be acceptable to HUD. The definition of a small business currently established by the Small Business Administration is no greater than $7 million in annual receipts.

Net Worth Requirements for 2013 and Subsequent Years

Effective as of May 20, 2013, in order to participate in FHA single family programs, all existing FHA-approved lenders (irrespective of their size), and applicants for approval to participate in FHA single family programs, will be required to have a net worth of at least $1 million, plus an additional net worth of 1% of their total loan volume in excess of $25 million of FHA single family insured mortgages originated, underwritten, purchased, or serviced during the prior fiscal year, up to a maximum required net worth of $2.5 million. No less than 20 percent of such required net worth must be liquid assets consisting of cash or its equivalent, as may be acceptable to HUD.

As noted above, existing FHA-approved lenders have one year to comply with the initial net worth increase to $1 million, and have two more years to comply with the additional volume-based net worth requirements. Existing FHA-approved lenders that are unable to meet the new net worth requirement within the proscribed deadlines must relinquish their FHA approval, but may continue conducting FHA business as non-FHA-approved TPOs, to the extent they are accepted by an FHA-approved lender as sponsor.

FHA-approved lenders participating in FHA multifamily programs are subject to higher net worth requirements that are not discussed in this article. However, note that if an FHA-approved lender participates in both single family and multifamily programs, such “dual approved lender” would be required to meet the higher multi-family net worth requirements.

New Rules for Principal-Agent Relationships

Generally speaking, in a Principal-Agent relationship, an authorized agent may perform part of the HECM origination process on behalf of the principal. FHA previously permitted a great deal of flexibility in structuring a Principal-Agent relationship, and either party was permitted to originate or underwrite the loan as long as they had the appropriate approval authority. However, the loan was required to be closed in the name of the principal.

The Final Rule has changed how the parties must structure the Principal-Agent relationship. Specifically, the principal is now required to originate the loan and the authorized agent must underwrite the loan. Further, both the principal and authorized agent must now be approved as Direct Endorsement (DE) lenders in order to participate in a Principal-Agent relationship. The loan may be closed in either party’s name. The Principal-Agent relationship must be recorded as such in FHA Connection.

Other FHA Changes

The Final Rule also incorporates certain changes arising from amendments to the FHA program made by the Helping Families Save Their Homes Act of 2009. The Final Rule requires FHA-approved mortgagees to use their HUD-registered business name in all advertisements and promotional materials related to FHA programs. A registered business name includes any alias or “doing business as” (or “DBA”) name on file with FHA. The lender must keep copies of all print and electronic advertisements, and promotional materials for 2 years.

The Final Rule also includes a requirement for FHA-approved lenders to notify FHA in the event the lender or its employee, including any officer, partner, director, principal, manager, supervisor, loan processor, loan underwriter or loan originator, are subject to sanctions or other administrative action. The Final Rule also updated the list of administrative actions and sanctions that disqualify an FHA-approved lender or a non-FHA-approved entity from participation in FHA programs.

No Exemption for HECM Loans

The Final Rule, in effect, allows non-FHA-approved entities to participate in the origination of FHA-insured loans. However, as industry participants are no doubt aware, HUD’s prior guidance expressly prohibited non-FHA-approved entities from participating and receiving compensation for the origination of FHA-insured HECM loans.

This interplay between the Final Rule and HUD’s prior guidance generated some concern among reverse mortgage industry members. The National Reverse Mortgage Lenders Association (“NRMLA”) raised this issue in comments submitted to HUD on behalf of the reverse mortgage industry.

Specifically, the Housing and Economic Recovery Act of 2008 (or “HERA”) added Section 255(n)(2) to the National Housing Act (or “NHA”), requiring all parties that participate in the origination of FHA-insured HECMs to be approved by HUD. HUD implemented this legislative initiative by Mortgagee Letter 2008-24.
 
In responding to NRMLA’s comments, HUD clarified that another piece of federal legislation enacted after HERA allows limited participation by non-FHA-approved entities in FHA programs, including the HECM program. Section 203(b) of the Helping Families Save Their Homes Act of 2009 (or “HFSH Act”) requires HUD approval of mortgage lenders participating in the origination of FHA-insured mortgages, “except as authorized by the Secretary.” HUD concluded that this language in Section 203(b) of the HFSH Act applies broadly to all FHA-insured single family loans thereby permitting HUD to authorize participation by non-FHA-approved TPOs in FHA programs, including the HECM program.

As is apparent, the Final Rule creates new requirements that may change the way originators and lenders conduct their business. Most importantly, however, these changes are ultimately designed to strengthen FHA and thereby ensure its long term viability. That result, given FHA’s critical role in promoting housing credit during these perilous times, is cause for optimism, harkening yet another Shakespearean muse when reflecting on the Final Rule - What light through yonder window breaks?

This article provides only an overview of some of the federal and state laws and regulations that may affect reverse mortgage lending, marketing and finance matters. Although the practice of Weiner Brodsky Sidman Kider P.C. is national in scope, attorneys within our firm do not actively practice law in all jurisdictions, and these materials are not intended to and do not provide legal advice. Because of the generality of this article, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

By Joel Schiffman and Fed Kamensky, of the law firm of Weiner Brodsky Sidman Kider, P.C. The law firm serves as General Counsel to the National Reverse Mortgage Lenders Association and advisor to reverse mortgage lenders and industry participants throughout the nation. The firm has offices in Washington, D.C., Newport Beach and Dallas. Additional information can be found at www.wbsk.com or by telephone at 202.628.2000. Messrs. Schiffman and Kamensky can be reached at This e-mail address is being protected from spambots. You need JavaScript enabled to view it and This e-mail address is being protected from spambots. You need JavaScript enabled to view it .

¹ Under the existing FHA parlance, there are four different classifications of “mortgagees”:  FHA-approved mortgagees (which can be either supervised or non-supervised), FHA-approved loan correspondents (which also can be either supervised or non-supervised), investing mortgagees and government mortgagees (i.e., a governmental institution or a GSE that is approved as an FHA mortgagee). As of the effective date of the Final Rule, FHA approval will only be available for FHA-approved mortgagees, investing mortgagees and government mortgagees. In this article, we refer to FHA-approved mortgagees as “FHA-approved lenders.”