New Compliance Requirements Add Challenges

More than ever, lenders could use innovative approaches to maintain loan integrity and compliance. Fortuitously, advanced technologies such as machine learning and business outcome automation are emerging as critical allies in the fight against the types of loan defects that frequently trigger costly repurchase demands. When incorporated into the loan review process, these tools have proven powerful catalysts for identifying potential risk areas and increasing accuracy and efficiency in loan QC processes.

When complemented by a large library of structured and unstructured documents, machine learning tools can analyze vast amounts of loan data and flag inconsistencies and anomalies that could signal defects — all in a fraction of the time it takes human auditors alone. Of course, the most effective approach lies in a synergy between technology and human expertise. While machine learning can process and examine data at incredible speeds, business outcome automation can provide straight-through processing and exception identification, giving human auditors more time to bring a nuanced understanding and judgment to the table, further decreasing the chances of errors and missing data that could lead to trouble.

For example, our audit and machine learning platforms now include 20 different component review options to create flexibility for lenders to meet prefunding review requirements. We have also created a well-defined post-close process that is now being used for all our post-close audit services clients. Our turn times and clients’ turn times across every phase of a project are clearly specified to keep all audits on track.

These technologies have broader operational benefits as well. By automating and accelerating their pre-funding QC and post-closing reviews, lenders can gain insights into defect trends earlier and focus on high-risk loan characteristics and defect avoidance. Defect trending and action plan tracking provide the controls needed to manage quality effectively. In a market environment where every lender is trying to optimize resources, ensuring closed loans are saleable can create huge competitive advantages.

Grappling With Change

Beginning Sept. 1, 2023, Fannie Mae required pre-funding QC reviews for a minimum of 10% of all loans, not just loans sold to them, or up to 750 loans per month. In addition, post-closing reviews, which were previously given a 120-day window, now must be completed in 90 days. This can represent a substantial increase in the volume of loans lenders must audit. It is likely only a matter of time until Freddie Mac mirrors this approach, reflecting a broader industry trend toward a greater focus on loan quality assurance.

In fact, Fannie and Freddie’s ongoing focus on enhancing loan integrity began in the wake of the 2008 financial crisis and continued with recent pandemic-driven market anomalies. It’s clear both GSEs are intent on minimizing the risk of loan defects, which are not just costly errors for lenders but also potential indicators of broader systemic risks in the housing market. For lenders, it means scrutinizing every detail of the loan production process, from underwriting to closing.

The stakes of non-compliance are high and can only erode profit margins already thinned by current market conditions. For more significant defects, especially those that affect the loan’s eligibility for sale to the GSEs, we have seen repurchase demand increase for loan vintages from when the industry volume was at its peak. Frequently, such defects are related to underwriting errors, including data involving the borrower’s income or the appraisal, as well as data errors and missing documentation.

A Tech Differentiator

Of course, ensuring loan integrity is not just a matter of GSE compliance, but it is crucial for maintaining a lender’s financial stability and reputation in the industry. Repurchases can have a substantial impact on the lender’s business, but for smaller organizations, they could be devastating. And yet, the current environment could also represent an opportunity to leverage automation to scale QC, not people. Lenders must learn to do more with technology — which, if implemented correctly, can create the business outcomes of better margins and lower defects that they seek.

No Time to Waste

Right now, every lender that sells to Fannie Mae or Freddie Mac is actively reconfiguring its teams and processes to adapt to these changes and meet new timelines. Because success in today’s mortgage industry hinges on being open to new ideas and resources, many are also examining options for both outsourcing and more automation via advanced technologies like machine learning and audit test sets to automate more pre-close, component, and post-close reviews. To be certain, there is no single blueprint for success. For most lenders, the ideal approach involves leveraging a mix of strategic thinking, technology, and operational agility.

Ultimately, the journey toward effective adaptation in the face of new QC requirements is ongoing. But one thing is clear: embracing change, adopting new technologies, and learning from peers are essential steps for ensuring not just compliance but also continued success. Just like chess, the mortgage game is never unwinnable — but similar to how chess masters never stop learning new offensive and defensive strategies, lenders must do the same if they hope to stay ahead.

As the mortgage industry continues to navigate these uncharted waters, learning from those already charting a successful course can be a game-changer. For this reason, I reached out to experts at leading lending organizations to find out how they could implement the internal changes and controls necessary to meet Fannie Mae’s new minimum requirement for pre-funding reviews and new post-close timeframe to consistently ensure loan integrity.

More to the point — how did they determine the right mix of pre-close and component reviews? And how successful were their efforts to complete post-close reviews in a 90-day window?

Their insights are a testament to our industry’s resilience and innovative spirit, which are thriving in spite of ever-evolving requirements and market pressures.

Helen Law
VP, Quality Control
Planet Home Lending

As vice president of quality control, I’ve led Planet through significant changes to align with the new QC requirements. Given our practice of selling to both Fannie Mae and Freddie Mac, we were generally prepared for the shift.

Overall, we focused on early sampling selections, gaining cooperation from business units and our correspondent lending partners, and reevaluated our structural and staffing strategies. Embracing Fannie Mae’s recommendation of a mix of pre-close and component reviews, we also increased our focus on component audits to address missing documents and income calculations, tailoring the approach to our specific channel mix.

Freddie Mac’s existing QC timeline already required post-close reviews to be completed within 90 days from the date of sampling, so meeting Fannie Mae’s timeline just involved moving up our cycle by about 15 days rather than a full 30 days.

We began implementing these changes a few months ago, and they have not come without challenges. Making our sampling selections earlier in the month ensured reverifications were received before our audits began. Gaining the cooperation of our business units and third-party originators was also important since the shorter timelines for identifying and curing defects demanded a more streamlined and concerted effort from all involved.

Fannie Mae suggests lenders implement a mix of pre-close and component reviews to increase the number of audits without adding more staff. In response, Planet is conducting a higher percentage of component audits to focus on missing documents and income calculations. For example, we are reviewing for gift/asset documentation on purchase loans or Other REO/Rental Income requirements on loans with multiple financed properties. Because every lender’s situation differs, this ratio might vary for other organizations based on capacity, risk profiles, and past QC results. Pre-close component reviews can also be used to test the success of an action plan in a timelier manner. Defects identified during pre-close reviews also have an immediate impact. By making the originations staff aware of items they are missing during processing it changes their behavior going forward.

Finally, we also had to rethink our structural and staffing strategies. While pre-fund component audits are less time-consuming compared to full audits, we were increasing the total number of reviews we conduct. This has impacted the way our team is organized and operates daily.

Julie Baril
Quality Control Manager
Norcom Mortgage

Since beginning as quality control manager for Norcom Mortgage four years ago, I’ve advised our operations team that we must work to respond to loan defects more quickly by providing five business days to respond to defects issued from a Post-Close QC review. My thinking is that the less time following a closing, the better chance we have at resolving any issues. If we are missing any information from the borrower, the transaction is still fresh in their minds.

This approach has helped us meet the GSEs’ new QC requirements without implementing much change. But it also meant I needed to get loans reviewed within a certain timeframe, so I began paying close attention to how many loans per day each analyst was reviewing and multiplied that by the number of working days in the coming weeks or months. At one point, we were pushing out all defects at once to begin our five-day timer easily. However, we realized we should be issuing defects as loans were being reviewed, especially if there were material defects, so we had a little more time to resolve them. I began assigning loans within the first few days of every month. This was a challenge since analysts were still looking at defect responses from the previous month, so we always had multiple months going on at a time. Now, we audit one month at a time and work hard to keep it that way.

We recently began taking things a step further by pulling loans for post-close review twice per month using a loan selection automation feature in our audit software. This way, our reverifications team can get started within the same month. To stay on track with this pace, we have to be right on top of the responses from our operations team. I also run reports as soon as defects are issued, so I know exactly what I’m dealing with and the next steps to take, rather than waiting to report at the close of rebuttal timeframes.

As for Fannie Mae’s recommendation on mixing full and component reviews, being a smaller organization, we lean towards full reviews as much as possible. Larger organizations might need more flexibility to meet their 10% requirement and address their risk management needs. Our selection process is driven by our previous audit findings, trends, or sometimes a repurchase that hits a particular area of concern.

After uncovering issues, we take immediate action to find the root cause and implement further training in that particular area. For example, after encountering two material errors based on appraisals, we initiated a pre-fund component review focusing solely on collateral. There are many reporting tools available with the GSEs and HUD to evaluate your organization’s quality reviews against your own. I strongly encourage use of those to help in the loan selection process.

We continue to move quickly in our review and response turn times for loan defects and analysis, but we always remain flexible to any changes taking place in compliance guidelines or industry trends.