Few things terrify lenders more than the arrival of a manila envelope from the Department of Housing and Urban Development (HUD) containing a redlining allegation.
In recent months, HUD investigators have made redlining cases a departmental priority, according to interviews with attorneys who have reviewed the complaints, and lenders who declined to comment on the practices for fear of being associated with redlining.
Typically, a redlining allegation begins with a comparative analysis of a lender’s performance in relation to its peers in low to moderate income census tracts and majority-minority neighborhoods. But HUD has adjusted its approach — it is now comparing a lender’s performance in different areas against itself.
A higher rate of withdrawn applications in certain tracts compared to the larger metropolitan area could result in a redlining allegation by HUD.
Independent mortgage banks have been “completely blindsided” by the increase in enforcement activity, said Daniella Casseres, who leads the mortgage regulatory practice group at law firm Mitchell Sander.
Redlining “is not even on the radar of their board or senior management,” she said.
Being labeled a redliner can cause lasting reputational damage because of its association with the historic definition of redlining, which federal policy supported for decades. As some independent mortgage banks have found out, a modern-day redlining allegation does not need to prove intentionality.
HUD complaints allege redlining based on disparate impact to borrowers on the basis of race or ethnicity, which is prohibited under the Fair Housing Act.
A spokesperson for HUD said the agency could not discuss investigations or strategy of fair lending enforcement, but said that fair lending is a priority of the Biden-Harris Administration and HUD.
“HUD’s work co-leading the Interagency Task Force on Property Appraisal and Valuation Equity (PAVE), as well as the number of actions taken in the first year of the administration to bolster enforcement of the Fair Housing Act demonstrates our commitment to the issue,” a spokesperson said.
Increased redlining enforcement is one piece of HUD’s renewed focus on fair lending, and part of a multi-pronged approach to address the legacy of racist housing policy.
HUD said it has already taken concrete steps toward that goal. It has begun to restore HUD’s discriminatory effects standard and requested a 17% budget increase for the Office of Fair Housing and Equal Opportunity for enforcement. In August, HUD Secretary Marcia Fudge signed an agreement with the Federal Housing Finance Agency to strengthen fair lending enforcement. HUD ended 40 years of ambiguity on a statute meant to spur lenders to target lending programs to benefit protected classes.
But HUD and the Federal Housing Administration have also struggled to navigate challenges posed by COVID-19 and correct long-standing deficiencies. Part of its effort to modernize its outdated technology systems, the FHA Catalyst program, hit a snag last year. FHA has had gaps in loss-mitigation oversight of servicers it approved. And although Fudge has repeatedly vowed to bring banks back to FHA, recent policy moves could drive them away.
In California’s Contra Costa County, where the median home listing price is now $749,000, a loan officer priced a loan for a potential borrower with less-than-perfect credit, who had found a listing for $650,000.
For a borrower with tarnished credit and thus unable to get conventional financing, an FHA-insured mortgage is the go-to choice.
But with a down payment of less than 10%, the borrower would have had to pay an additional $11,375 in upfront fees to FHA, due to FHA’s 175 basis point mortgage insurance premium, which it charges on nearly all loans.
John Meussner, the loan originator who priced the loan, said the fees amounted to “gouging.”
In addition to upfront fees, FHA charges fees for the life of the loan. For a 10% down payment, a hypothetical FHA borrower with a $650,000 base loan amount would pay an additional $568 per month in mortgage insurance premium.
The recurring monthly fee leads some borrowers to refinance out of their FHA loan, since unlike in the conventional market, there’s no getting rid of it. By comparison, private mortgage insurance cancels at a 78% loan-to-value ratio.
“If FHA and HUD want to serve their purpose of assisting low-moderate income customers and increase home ownership, the best place to start would be to stop ripping off the very people they’re attempting to serve,” said Meussner, of Mason-McDuffie Mortgage.
The share of FHA-backed mortgages made to Black and Hispanic borrowers are more than twice that of the rest of the market, public data shows. Four in five FHA purchase mortgages went to first-time homebuyers in 2021.
FHA’s mortgage insurance premium earnings helped propel the Mutual Mortgage Insurance fund’s capital ratio to 8.03% in 2021, four times the statutory minimum. The estimated value of monthly insurance premiums through the life of the loan as of last year was $49 billion, according to HUD’s annual report to Congress.
In light of the stellar mutual mortgage insurance fund report, some stakeholders expected FHA to reduce mortgage insurance premiums. Many have called for reductions.
The executive director of one state housing finance agency said a small reduction is “probably warranted” based on the health of the fund. But the official, who requested anonymity to speak openly about the department, also said he understands FHA’s cautious approach, since FHA officials may still recall the years that followed the housing crisis, when the fund fell below the required ratio.
Lopa Kolluri, principal deputy assistant secretary of FHA, said in an interview that FHA would reassess whether to lower premiums closer to the end of the first quarter. In terms of making a decision on lowering mortgage insurance premiums, she said it depends on the share of seriously delinquent borrowers.
“We’re encouraged by the serious delinquency rate decreasing, but it’s too early to make predictions,” said Kolluri. “We believe we’ll have a better indication of performance later in the calendar of this first quarter.”
But former officials and stakeholders defend FHA despite the steep fees, because it fills a need for borrowers not served by the rest of the market. Those borrowers would otherwise face steep loan-level price adjustments for conventional financing.
“The point is that [FHA] is a durable program,” said Edward Golding, who led FHA from 2015 to 2017. “Yes, it could be made better, yes, you could lower prices, but it’s not terribly broken and it’s not a terribly different program today than five years ago or 25 years ago.”
Building blocks, stumbling blocks
On the strength of FHA’s mortgage fees and appreciating home prices, HUD’s Mutual Mortgage Insurance fund is in a better financial state than ever. But in addition to answering calls to lower upfront and life-of-loan fees to borrowers, FHA has some unresolved policy questions.
In recent years, large depositories have ceased FHA lending. They’ve exited the space due to concerns of increased use of the False Claims Act to extract settlements, and independent mortgage banks have supplanted them. In October, speaking at an industry conference, Fudge vowed to make it easier for more financial institutions to partner with FHA and Ginnie Mae, “whether for the first time or for the first time in a long time.”
“We want to bring more banks and financial institutions of all kinds and sizes back to FHA,” Fudge said.
But mortgage is only one among a suite of products that large depositories offer, and is not critical to their business strategy. Thus FHA lending is not necessarily a “natural fit” for large depositories, said Golding.
“So one shouldn’t be too surprised to see mortgage banks, on average very reputable companies that invest in technology and know how to deliver the product, more represented in FHA lending. Mortgage banking is not a product that large depositories immediately flock to.”
Golding said returning to FHA would help depository banks to serve a broader market and meet the needs of a more diverse set of customers.
But FHA has recently taken positions that, instead of reeling large depositories back in, industry stakeholders say are in conflict with that goal.
In December, the FHA released a draft defect taxonomy, a list of what remedies the agency may seek if it finds loan-level defects pertaining to servicing. The mortgage industry and housing advocates criticized the document as overly vague and said it would further chill the market.
After stakeholders––including the powerful trade group Mortgage Bankers Association––wrote and requested additional time to weigh in on the draft defect taxonomy, FHA extended the public comment period by a month, to Jan. 28.
Kolluri said that partnering with larger banks is crucial for narrowing the racial homeownership gap, especially because depository banks have physical branches in underserved communities.
“A number of these banks have made major commitments within communities, and we want to help them fulfill those communities,” said Kolluri. “It’s a really natural extension of the work they’re doing as it relates to the Community Reinvestment Act, and we have heard and met with larger banks who have made significant monetary commitments in those communities.”
In addition to working through industry feedback on the defect taxonomy, Kolluri said that the clarifying legal position HUD issued in December on special purpose credit programs would provide clarity for banks.
Lenders have been reluctant to create the targeted loan programs under the new guidance, in part because of concerns that designing a program could make them vulnerable to redlining claims. On Jan. 26, Secretary Fudge convened the heads of seven federal agencies — including the FHFA and the Consumer Financial Protection Bureau — to review their regulations, guidance, and examination guidelines to identify any remaining barriers for creating targeted loan programs.
FHA has also long struggled to modernize its information technology systems, which lag far behind the relatively advanced capabilities of Fannie Mae and Freddie Mac.
Unlike the government-sponsored enterprises, FHA is bound by congressional appropriations for budget items, and it cannot use revenue from premiums to invest in itself.
“There’s a massive mismatch, in that we have the largest insurance in the world sitting on the government balance sheet, with no ability to invest even a portion of its massive profits back into keeping the company current and less risky,” said Dave Stevens, who was FHA commissioner during the Obama administration.
In 2017, Congress started appropriating $20 million a year specifically for FHA IT modernization, and FHA and HUD’s IT management consolidated, reducing redundancies. But a HUD inspector general report found that the agency’s premier IT modernization effort stalled last year.
For a time, staff vacancies and turnover were so acute, especially during the presidential transition, the report said, that the executive committee in charge of leading the FHA Catalyst program disbanded, and work on the initiative was temporarily halted.
“We found a lack of staffing capacity, implementation of effective coordination and communication practices, and effective oversight of management controls over acquisition processing,” the report read.
HUD also delayed a migration planned for December 2021 — to move its single-family default monitoring to FHA Catalyst — until March 2022, when mortgagees must submit all default data to the FHA Catalyst system.
Part of the challenge of updating the IT systems is that there are often more urgent priorities, and taking resources away from immediate needs to spend them on IT modernization is difficult.
Kolluri said there are many other “critical areas” that HUD is attending to, in light of Covid, although “modernization and transformation of FHA’s IT program is a high priority.”
“Yes, we had some delays, absolutely,” said Kolluri. “But we are on track. I feel really good about where we are with FHA Catalyst.”
In December, seven former HUD secretaries met with Fudge to offer their support for what some colloquially call the second-most challenging job in the federal government.
When the group did the same for the previous HUD secretary, Ben Carson, the topic was a surge in homelessness. This time around, the meeting was remote, and the conversation centered on affordability, particularly for first-time homebuyers.
It was a bipartisan group of four Republicans and three Democrats, Clinton-era HUD Sec. Henry Cisneros said.
The collegial gesture was a brief hiatus from partisan politics which, in the Senate, have stalled a number of President Joe Biden’s HUD nominees, including his pick for FHA commissioner, Julia Gordon.
Gordon has faced staunch opposition from Republicans on the Senate Banking Committee over past, now-deleted tweets critical of the police. Votes in January for four of five of Biden’s HUD nominees, including Gordon, as well as Arthur Jemison, former CFPB Acting Director David Uejio and Solomon Greene, ended in ties.
The Senate will now have to dedicate precious floor time to debate Gordon’s nomination. Making it even less convenient, sources say that it is likely that Vice President Kamala Harris would likely need to be present to break the tie.
Jenn Jones, FHA’s chief of staff, told reporters in January that “government works better when you’ve got a full array and slate of committed, capable public servants to lead the work.”
“Obviously we are still hopeful that the senate will move quickly to confirm all of our nominees that are awaiting confirmation,” Jones said.
A Washington, D.C. lobbyist, who works with FHA lenders, said that while Fudge’s vision for HUD is “150% aligned” with the Biden administration’s push to reduce the racial homeownership gap, she needs a bold leader at FHA. There is natural tension between career officials, who weather political changes and implement policy, and political appointees, who set the agenda.
“Fudge needs a leader at FHA, because [FHA] career staff are cautious,” said the lobbyist. “They don’t want to alienate the bosses. That’s why Julia Gordon will be instrumental.”
A confirmed FHA commissioner can also “guide and temper” the approach of career officials, including in relation to enforcement matters, said Stevens. “It’s important to not let long term career lawyers try to take advantage of the time when they don’t have mom and dad in the room.”
But a large portion of Fudge’s direct reports are held up at the Senate, and Biden has yet to nominate two more outstanding assistant secretary roles at HUD. Not having a leadership team in place makes it difficult to set policy, and address even urgent matters.
“If the Secretary can’t turn to someone, it’s very, very difficult,” said Cisneros. “Even when you see a sore thumb kind of problem.”