On February 2, 2016, Freddie Mac and Fannie Mae took another step towards helping sellers of loans manage risk more effectively, and in turn, strengthen the home lending system.
Through concurrently released announcements, Freddie Mac and Fannie Mae, at the direction of the Federal Housing Finance Agency (FHFA), jointly announced the Independent Dispute Resolution (IDR) process. Freddie Mac’s Bulletin 2016-1 explains that the IDR process provides sellers of loans an opportunity to request a neutral third party arbitrator to settle disputes regarding alleged loan-level origination defects. This announcement marks the completion of the selling representation and warranty framework, which was first introduced on September 11, 2012 in Bulletin 2012-18.
Each referenced Freddie Mac Bulletin includes updates to the Single-Family Seller/Servicer Guide, which contains Freddie Mac’s selling and servicing requirements. Similarly, Fannie Mae concurrently distributes these statements as Announcements, which update the Fannie Mae Selling Guide. Beginning with Bulletin 2012-18, Freddie and Fannie have limited those situations when remedies, such as a repurchase demand, will be sought, and have provided sellers with a clearer framework under which to issue loans. This goal was advanced by Bulletin 2014-8, which introduced relaxed acceptable payment history requirements, and Bulletin 2014-21, which better clarified situations that do not qualify for relief from the remedy provisions.
The Disputes
The IDR process is available for disputes related to alleged loan-level origination defects for Mortgages acquired by Freddie or Fannie on and after January 1, 2016. A defect occurs when a Mortgage sold to Freddie or Fannie does not comply with the requirements in the purchase agreement (i.e. breaches of representations or warranties). As explained by the newly implemented remedies framework provided by Bulletin 2015-17, Freddie and Fannie will categorize each origination defect in one of three ways: (1) Findings; (2) Price-Adjusted Loans; or (3) Significant Defects.
Only defects categorized as “significant defects” may require the repurchase of the mortgage or a repurchase alternative, such as an indemnification agreement. A significant defect is one that either necessitates a change to the price on which the Mortgage was acquired or results in the Mortgage being unacceptable for purchase had the true and accurate information about the Mortgage been known at the time of purchase.
Essentially, if the defect resulted in the wrong price being paid for the Mortgage or caused Freddie or Fannie to purchase a Mortgage that did not meet the requirements of the purchase agreement, it is a “significant defect.”
The Process
In the event of an alleged “significant defect,” Freddie or Fannie will issue a demand for repurchase or other remedy. The seller then has the opportunity to correct the defect or appeal the demand. If the issue is not resolved, the seller can again appeal, rebut, or provide further evidence that the defect does not exist or has been corrected. In instances that remain unresolved after the second appeal, an escalation process is available. Bulletin 2016-1 explains that Freddie and Fannie will update the appeal and escalation processes in 2016, in order to more clearly describe the ability of sellers to appeal and escalate prior to initiating the IDR process.
If the dispute remains unresolved after the appeals and escalation steps are completed, either the seller, Freddie, or Fannie may elect the IDR process. The IDR process, while new and not fully incorporated into the Freddie and Fannie guides, will provide a cost-effective and clearly defined alternative to bringing a claim in court. Bulletin 2016-1 sets forth components that the IDR process will incorporate, such as timelines for initiating IDR and selecting a neutral arbitrator, the option of each party to use legal counsel and experts, and a hearing with an arbitrator conducted by telephone or videoconference, among others. Lastly, the party that does not prevail at the IDR hearing will be responsible for paying the prevailing party a “Cost and Fee Award” in the amount of 10% of the unpaid principal balance of the related Mortgage at the time the Mortgage was acquired.
The Result
The IDR process will likely only apply to a small share of disputes, given that the current appeal and escalation process will remain (and be improved upon). However, the new IDR process should provide confidence for lenders, because there now is an opportunity to resolve disputes regarding alleged origination defects without needing to bring a claim in court. Importantly, Bulletin 2016-1 anticipates that the IDR process will also become available for servicing-related disputes in the future, which will be yet another step towards Freddie and Fannie’s goals of ensuring liquidity in the housing finance market and providing greater access to credit for borrowers.
