Treatment of Loan Purchase Eligibility Under GSE Equitable Housing Plans

On June 6, 2022, the US Federal Housing Finance Agency (“FHFA”) released the first three-year Equitable Housing Finance Plans (the “Plans”) of Fannie Mae and Freddie Mac (“GSEs” or the “Enterprises”).¹ In a prior Legal Update, we described stakeholder responses to the FHFA’s September 2021 Request for Input (“RFI”) seeking public input and information to assist in the Enterprises’ preparation of their respective Plans.

The Plans offer a comprehensive background on the foundation of housing inequity, particularly as a result of government policy, and the results of such inequities. What they do not offer are discrete proposed changes to the Enterprises’ eligibility criteria for the purchase of mortgage loans, although they do explicitly address certain inputs to the data elements on which eligibility criteria are based, such as the accuracy of appraisals and the use of alternative data for cash flow underwriting. They also propose the expanded use of Special Purpose Credit Programs (“SPCPs”) as a form of a laboratory or incubator to test the efficacy of various changes to their processes and criteria, both individually and collectively.

I. Background

FHFA required the Enterprises to submit their Plans by last December (to become effective in February 2022) and to include objectives, measurable goals, and planned meaningful actions related to reducing:

• The racial or ethnic homeownership gap and
• Underinvestment or undervaluation in formerly redlined areas that remain racially or ethnically concentrated areas of poverty or otherwise underserved or undervalued

Additionally, FHFA provided the Enterprises with a non-exclusive list of objectives and goals, including reducing:

• Racial or ethnic disparities in acceptance rates for the Enterprises’ respective automated underwriting systems (“AUS”) and
• Racial or ethnic disparities in the share of loans acquired by the Enterprises compared to the overall mortgage market

The September RFI posed 12 specific questions for comment, although, as we previously noted, most of the public responses did not specifically answer each of the 12 questions and instead centered on common themes. Our Legal Update only focused on one of the themes pertaining to the Enterprises’ purchases of residential mortgage loans, including underwriting criteria, product types, loan size, and loan pricing. After evaluating the RFI comments from industry stakeholders, FHFA published the Plans of the Enterprises.

II. Overview on Plans

The Enterprises’ Plans are designed to complement the initiatives outlined in FHFA’s Strategic Plan: Fiscal Years 2022–2026, which promotes the Enterprises’ safety and soundness and fosters housing finance markets that provide equitable access to affordable and sustainable housing.² The activities outlined in each of the Plans, which are required to be updated annually, address barriers experienced by renters, aspiring homeowners, and current homeowners—particularly in Black and Latino communities. These activities include consumer education initiatives for homeowners, credit reporting to help tenants build credit profiles and enable better access to financial services, and SPCPs to address barriers to sustainable homeownership.

Consistent with our prior Legal Update, we focus in this piece on the Plans’ approaches to purchases of residential mortgage loans. The Plans otherwise, for example, address ways to help actual and prospective renters; provide generalized assistance to prospective borrowers, such as tools to compare average closing costs and initiatives to lower closing costs (e.g., title and private mortgage insurance); improve sustainability of homeownership; tinker with servicing; and seek to remedy some of the more systemic causes of housing inequity. Taking this approach, the Plans are short on specifics and long on intentions, indicating that the Enterprises will scrutinize processes and standards that may be hampering housing equity. The Plans call for a comprehensive approach to eradicating the results of prior housing policies and discrimination. As a more direct approach, though, both Enterprises plan to enthusiastically pursue SPCPs as a way to improve housing equity in the short run.

III. Summary of the Plans’ Approaches to Purchase of Eligible Mortgage Loans

A. Special Purpose Credit Programs

Fannie Mae aims to execute a series of SPCP pilots to help support the expansion of homeownership eligibility and availability of down payment assistance while exploring ways to reduce SPCP participation hurdles for lenders.³ These are, whether executed singularly or in combination:

• Expansion of Eligibility: Create a HomeReady® or similar program specifically for use with its SPCP pilots. HomeReady® is a Fannie Mae loan program for credit-worthy, low-income borrowers. This program would extend the benefits of the HomeReady® product to borrowers with income levels greater than 80 percent of area median income in the SPCP areas who are purchasing or refinancing a principal residence. Potential benefits include lower down payment requirements; underwriting flexibilities, such as expanded sources of funds for down payment and closing costs; mortgage insurance (“MI”) cost reductions through lower-than-standard MI requirements; and reduced pricing through lower LLPAs. These pilots would allow Fannie Mae to test which of these benefits, or combinations of benefits, are the most effective. In addition, it plans to test expanded credit criteria, such as allowing for greater usage of boarder income. It will also encourage SPCP pilot lenders to use positive rental payment data in DU® as part of their loan process in order to help increase credit access for applicants with thin credit histories.
• Down Payment Assistance: Allow DPA funds, in some cases at a substantial level, from one or more of a variety of sources. Potential sources include lender-funded, Fannie Mae-funded, non-profit-funded, Housing Finance Agency- (“HFA”) or government-funded, or some combination of these.
• Local Government Programs: Identify opportunities for Fannie Mae to work with eligible recipients of funds from local government programs established to address housing discrimination and wealth inequity. Apply the SPCP scenarios described above as appropriate. Listen to stakeholders in communities with these programs to learn what help they most need. Assess opportunities to bring industry stakeholders to the table (e.g., lenders, mortgage insurance companies, etc.) to further help eligible recipients. Document learnings and explore where Fannie Mae can apply to other emerging programs so that these loans can be salable to the Enterprise.
• Reduce Hurdles for SPCP Participation: Identify barriers to lender participation in SPCPs through a market insights survey and create opportunities for increased participation (e.g., clarification or changes to its Selling Guide) so that loans can be salable to Fannie Mae.

Fannie Mae will execute an SPCP pilot to support the reduction of borrower closing costs for Black homebuyers via appraisal products, appraisal reimbursements, and/or title products. This will provide an offering in connection with one or more of its SPCP pilots to test the use of appraisal reimbursements, appraisal products, or title products in certain target geographic markets to reduce borrower closing costs for Black homebuyers.

Fannie Mae will test adding ongoing education and counseling support to one or more SPCP pilots to strengthen borrower housing stability over time. By constructing this SPCP pilot in target geographic markets that combines a mortgage with Fannie Mae new homebuyer education and post-purchase counseling, the Enterprise will be able to test the effectiveness of adding homebuyer education and post-purchase counseling onto its SPCP pilots.

Lastly, it will test add-on features to one or more SPCP pilots aimed at strengthening ongoing borrower stability by helping borrowers deal with unexpected expenses and repairs or with temporary disruptions to income. This initiative will explore additional features that Fannie Mae can add on to its proposed SPCP pilots to support ongoing homeownership stability such as mortgage reserve accounts, home warranty products, or flood insurance.

Freddie Mac’s Plan will seek to address the homeownership gap for Black and Latino borrowers through responsible and impactful initiatives that expand access to credit, implemented primarily through SPCPs.

Freddie Mac plans to purchase loans originated through SPCPs. Its initial research supports identifying a special need for minority borrower communities and borrowers in census tracts with a non-white population greater than 50 percent. Per Freddie Mac, there is a growing interest among lenders in originating loans under an SPCP and selling the loans to the Enterprise. Freddie Mac also indicated it will review lender SPCPs and establish terms of business that will permit lenders to sell the Enterprise loans originated under its SPCPs. It may also update the Freddie Mac Single-Family Seller/Servicer Guide to include requirements for selling loans originated under a lender SPCP.

Freddie Mac has prepared a model SPCP written plan for any SPCP it may design and will begin implementation planning later in 2022. It will develop and implement an SPCP that offers some or all the following benefits: (a) down payment assistance, (b) improved pricing/reduced fees, (c) expanded underwriting, (d) reserve funds for borrower hardship, and (e) expanded loan servicing to an identified class of borrowers. Lenders may identify other special social needs with supporting evidence that warrants the formation of a well-designed SPCP with special social needs.

It is also continuing to research how best to structure and implement an SPCP for optimal impact, including refining its geo-targeting, such as targeting Majority Minority Census Tracts, targeting geographies based on home loan origination, targeting geographies that have above-average concentration of mortgage-ready Black and Latino renters, and targeting geographies based on key economic indices. For example, the Area Deprivation Index (“ADI”) allows for rankings of neighborhoods by socioeconomic disadvantage in a region of interest (e.g., at the state or national level). It includes factors for the theoretical domains of income, education, employment, and housing quality. The ADI is one of many indices that Freddie Mac may utilize as a geographic targeting tool to reach Black and Latino populations more efficiently than by using MMCTs.

By targeting individuals instead of geographies, Freddie Mac may make its SPCP accessible to anyone who self-identifies as Black, Latino, or American Indian/Native American. Another demographic Freddie Mac seeks to explore is the first-generation homebuyer. Freddie Mac continues to evaluate potential special social needs as well as the risks and operational challenges posed by this type of targeting.

B. Debt-to-Income Ratios

Despite the many targeted comments submitted in response to the RFI, the Enterprises provided no explicit changes to the use of debt-to-income ratios in manual underwriting of applicant eligibility. Rather, these comments are addressed through the proposed use of SPCPs or other programs, as described above. As noted below, however, there is a focus on the income side of the debt-to-income ratio.

C. Automated Underwriting Systems/Credit Scores

Fannie Mae intends to expand eligibility and access for credit-invisible borrowers through an enhancement of its AUS, Desktop Underwriter (“DU”), both to conduct cash-flow underwriting (such as data from consumers’ deposit and card accounts) for applicants without a credit score due sometimes to a lack of a credit history and, as detailed below, to obtain and use positive rental data reported to credit bureaus. In addition, implementing automated validation of non-traditional trade lines in DU will facilitate the focus on underwriting with alternative non-traditional credit information.

The Plans do not change the Enterprises’ use of minimum credit scores as part of their respective underwriting criteria, but Freddie Mac is developing a version of its AUS that does not rely on third-party credit scores, although it did not elaborate on what it would use in its place. It also intends to investigate and develop a plan to leverage alternative credit data where appropriate. Freddie Mac also wants to pursue technological and credit policy analysis to determine the most effective methods of incorporating this financial information into the lending process to assess applicant account data and patterns to increase access to credit for underserved consumers.

The Enterprises want to develop a program for multifamily borrowers/landlords to report timely rental payments to the credit bureaus. These Plans indicate that these proposed changes will provide opportunities for applicants who do not own a home to bolster their credit history and increase their credit score through the inclusion of positive rental history.

D. Loan-to-Value Ratios

With one notable exception, the Plans do not propose any changes to required loan-to-value ratios. Rather, the Plans focus their attention on disparate undervaluation of properties in minority communities. After all, the key to the calculation of a reliable loan-to-value ratio is an accurate property value.

Freddie Mac plans to allow use of its Automated Collateral Evaluation (“ACE”) tool for purchase transactions with higher loan-to-value ratios with risk mitigants such as an onsite property data report or home inspection for SPCP-eligible borrowers, which Freddie Mac believes will help mitigate appraisal gaps for Black and Latino borrowers. This policy change would not revise the required loan-to-value ratios from an underwriting perspective but would permit loans with higher loan-to-value ratios to qualify for a waiver of Freddie Mac’s appraisal requirement than are currently eligible.

E. Appraisals

Fannie Mae aims to modernize its valuation methodology in order to support an equitable appraisal process for Black households and communities of color. Fannie Mae believes it can leverage data analysis, quality control (“QC”), monitoring trends, industry engagements, and technology. Fannie Mae’s 2022 Appraisal Bias Work Plan incorporates all of these elements in order to reduce the potential for appraisal bias.

Freddie Mac will develop an Appraiser Quality Monitoring framework that leverages modern technology features, as well as staff internal team leveraging tools to identify, assess, monitor, and mitigate risks such as the “Appraisal Gap.” The framework will include feedback communications to appraisers and lenders to remediate any observed trends.

In addition to expanding the availability of ACE, Freddie Mac will focus on several enhancements to ACE to assist the Enterprise and its lenders in identifying and reviewing appraisals that may be at a higher risk for inappropriate undervaluation or the use of biased words or phrases (e.g., pride of ownership, crime-ridden, etc.).

Each of the Enterprises described their intent to work on increasing diversity within the appraisal industry. For example, they intend to expand their Appraiser Diversity Initiative to attract new and more diverse entrants to the residential appraisal field, overcome barriers to entry (such as education, training, and experience requirements), and foster diversity, which it believes will help to reduce appraisal bias against minority homebuyers, homeowners, and communities over the long term. Freddie Mac commits to providing input to the Appraisal Foundation’s Appraisal Standards Board and its Appraisal Qualification Board with respect to establishing, improving, and promulgating uniform standards of professional appraisal practice, as well as the qualification criteria and minimum education required for new appraisers. Freddie Mac hopes to promote appraisal standards, provide objective and unbiased appraisals, and ensure that qualifying criteria do not provide barriers to entry.

F. Down Payment Assistance

Initiatives related to down payment assistance discussed in the Plans are limited to SPCPs, as described below. Freddie Mac aims to provide and promote down payment assistance tools with industry partners serving Black and Latino communities by developing a digital platform (“DPA Tool”) to maximize down payment assistance program utilization nationwide and to increase incremental originations by seamlessly connecting and matching down payment assistance programs, lenders, counselors, and borrowers. Freddie Mac will continue its efforts to drive down payment assistance utilization, standardization, and funding. It plans to promote the DPA Tool with industry partners serving Black and Latino communities to increase utilization of down payment programs—affinity trade associations, nonprofit housing organizations, housing counselors, housing advocates, and consumer groups.

G. Loan Size

The Plans do not address ways to encourage the delivery of small-balance loans, except as noted below under Loan Pricing.

H. Loan Pricing

Freddie Mac plans to evaluate changes to its loan-level price adjustments (“LLPAs”) structure, including minimizing LLPAs for loans originated under SPCPs, to help it achieve its equity objectives. It is also exploring pricing changes to incentivize more lending at low loan balances. Freddie Mac also plans to further engage with lenders and conduct deeper analysis to understand how its pricing construct can be better optimized to support more lending to first-time homeowners. While Fannie Mae addressed closing costs, it did not reference LLPAs in its Plan except in connection with SPCPs.

I. Loan Product Types

Freddie Mac aims to (1) leverage and expand its forward commitment construction take-out loan offerings, (2) provide liquidity to small institutions in the ground-up affordable construction to permanent lending market, and (3) develop a construction-to-permanent loan purchase offering in order to execute this action. Freddie Mac aims to provide financing through rehabilitation loans to improve the quality of affordable, decent, safe, and sanitary housing, including properties available in racially or ethnically concentrated areas of poverty, formerly redlined areas, and other geographic areas of underinvestment. Freddie Mac aims to address threats to housing affordability by expanding existing and exploring new loan offerings that mandate affordability restrictions through Freddie Mac’s loan agreement. Per the Enterprise, this approach will allow private investment capital to be directed toward preserving affordability and will allow limited public subsidy to be applied where it is most needed and most effective.

IV. Conclusion

The Enterprises have taken a proactive approach to make changes with consumers and industry comments in mind. While primarily relying on SPCPs is an interesting approach to executing the initiatives, the Plans align with the FHFA’s and Enterprises’ initiatives to expand minority homeownership in the near future.

¹ FHFA Announces Equitable Housing Finance Plans for Fannie Mae and Freddie Mac, available at https://www.fhfa.gov/Media/PublicAffairs/Pages/FHFA-Announces-Equitable-Housing-Finance-Plans--for-Fannie-Mae-and-Freddie-Mac.aspx (last visited July 25, 2022).

² Fannie Mae Equitable Housing Finance Plan, available at https://www.fanniemae.com/about-us/esg/social/equitable-housing-finance-plan; Freddie Mac Equitable Housing Finance Plans, available at https://www.freddiemac.com/about/diversity.

³ HUD Publishes Guidance Concluding That SPCPs Are Permissible Under the Fair Housing Act, available at https://www.cfsreview.com/2021/12/hud-publishes-guidance-concluding-that-spcps-are-permissible-under-the-fair-housing-act/.