New Fannie Mae Regulations Could Pose Problems For Borrowers and Lenders

The trials and tribulations of Fannie Mae have been well documented on this blog and throughout the media.  Seized by the federal government in 2009, Fannie Mae has required $84 billion of taxpayer funds to remain solvent.

On June 1, 2010, Fannie Mae’s new Loan Quality Initiative (LQI) becomes effective.  The purpose behind the LQI is to detect compliance issues with Fannie Mae mortgages prior to delinquency or foreclosure. Over the last three years loan repurchase requests have increased, which has demonstrated the need for an improvement to the underwriting process.  The emphasis is on getting more complete underwriting data that might uncover problems with loans before they are issued.

Part of the LQI requires any lender who wishes to sell mortgages to Fannie Mae to “determine that borrower liabilities incurred up to, and concurrent with, closing are disclosed and evaluated in qualifying the borrower for the loan”.  The best way to do this is to run an additional credit report before closing.  The LQI does not explicitly require a credit check, but lenders will likely run one to meet the requirements.

Running a second credit check could have big implications.  The first issue is if a borrower has undertaken any new debt during the loan process.  If they have, the closing could be delayed until the lender is able to look into the issue further.

Let’s take the example of a borrower who submits a loan application, but before closing finds themselves in need of a new vehicle which necessitates an auto loan.  Prior to closing, the lender runs an additional credit report, and sees the new debt.  The lender finds that the borrower’s Debt-To-Income (DTI) ratio has increased from the original credit check.  This could cause the loan to fall through because the new DTI makes the borrower ineligible for the loan.

A second issue will arise if no new debt has been incurred, but there has been a change in credit score between the first and second report.  A credit score could change due to a late bill payment, a credit inquiry, opening a new credit card, or a variety of other factors.  The LQI requires the lender to resubmit any borrower where “new derogatory information is detected and/or the credit score has materially changed”.  The trouble is that Fannie does not specify what constitutes a “material change” to the credit score.

As we can see, the LQI could cause trouble for borrowers and lenders until some of the rules are further clarified.  Borrowers would be well advised to not take on additional debt or do anything that would cause negative changes to their credit score prior to final closing on a home.