The Future of Residential Lending: Key Factors

By Joseph J. Reilly

There are too many key factors driving the future of real estate lending to list and describe on one page. But here are the few that BuckleySandler believes will be most important:

Managing repurchase risk/False Claims Act. Perhaps the most obvious factor will be the element of repurchase risk and, relatedly for loans insured or guaranteed by federal agencies, indemnification and False Claims Act risk. Since the financial crisis, lenders have been forced to repurchase and/or reimburse the government for billions of dollars of mortgages. The heavy price paid in connection with buybacks and related indemnity demands is fresh in lenders’ minds and is a strong incentive to make only the highest quality loans going forward. Because repurchase risk is a driving factor of tightening credit, the industry’s ability to inject more certainty and transparency into the repurchase process could be a major determinant of whether credit will be loosened.

The need for clarity and transparency is particularly acute with respect to FHA loans. A key factor for indemnification and False Claims Act risk will be the enforcement posture of the Justice Department and individual U.S. Attorney’s Offices, which do not always appear to act in sync with housing policy-makers’ goals of making loans to underserved borrowers.

Future of Fannie Mae and Freddie Mac. Repurchase risk is so important because the secondary market drives origination activity—indeed, even portfolio-focused lenders want to know that market is liquid. But the future of the biggest players in that market, Fannie Mae and Freddie Mac, is now up in the air. How and when Congress addresses the future of Fannie Mae and Freddie Mac, now in their eighth year of conservatorship, will therefore dramatically affect the liquidity of the secondary market and, thereby, the future of real-estate lending. But what Congress will choose and when it will act are, frustratingly, impossible to predict with accuracy.

Will tight credit standards increase fair lending risk? And will the Supreme Court change the law of fair lending? Because of repurchase risk, increased regulation and mounting penalties and costs associated with even minor violations, credit standards for today’s residential mortgage are tight. The resulting restricted access to credit for low- and middle-income borrowers, of course, disproportionately affects minorities, which further widens the gap in homeownership rates between whites and minorities, who make up a growing share of the first-time homebuyer market. Unless credit standards ease, then we may see an increase in fair lending challenges—or at least an increase in fair lending compliance costs.

This analysis, however, is based on fair lending law as of this writing, which permits “disparate impact” as a theory of liability (in addition to “discriminatory intent”). By June, the U.S. Supreme Court will have decided in the Texas Department of Housing case whether the disparate impact theory remains viable under the Fair Housing Act. If the Court rejects the disparate impact theory, fair lending compliance programs will likely become less intense.

Lender entry into the non-QM space. A number of incentives are expected to continue to tempt lenders to enter the non-Qualified Mortgage space, including interest-only products for high net worth individuals, alternative income documentation for self-employed borrowers, and higher upfront costs for borrowers on the lower end of the credit spectrum. However, this market will likely remain fragile until greater comfort develops regarding regulatory expectations, litigation risk, and repurchase risk. Judicial decisions on ATR/QM challenges, however, could take years to materialize.

If there is a common theme for the factors here, it is the question of how much each of them will cause credit standards to remain tight, and whether a restricted market will increase fair lending risk.

Joseph J. Reilly is the author of The New CFPB Mortgage Origination Rules Deskbook, free to ABA members, and a partner at BuckleySandler, LLP