No More Mister Nice Guy: Indemnification Now Required by FHA Lender Insurance Regulations

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FHA mortgagees participating in the Lender Insurance (“LI”) program will be required to indemnify
HUD for self-endorsed loans that HUD deems ineligible for FHA insurance based on a final
regulation published by the U.S. Department of Housing and Urban Development (“HUD” or
“Department”) on January 25, 2012.

The regulation finalizes changes to the LI regulations proposed in October of 2010 and will take effect
on February 24, 2012. In addition to the significant changes to HUD’s indemnification authority for
self-endorsed loans through the LI program, the final regulation also: (1) amends mortgagee eligibility
criteria to participate in the LI program, including acceptable default/claim rates; (2) amends the
Department’s authority to monitor lenders participating in the LI program; and (3) implements a
process for FHA lenders terminated from the LI program to request reinstatement of their LI authority.

In announcing both the proposed and final versions of these regulatory changes, HUD made clear that
these amendments are designed to improve and expand the risk management activities of the FHA and
to strengthen the FHA Insurance Fund by limiting “unnecessary and inappropriate risks” to the Fund
associated with loans that the Department determines should not have been endorsed through the LI
program.i As HUD notes, this is the latest in a series of steps the Department has taken to strengthen
the financial soundness of the FHA program and mitigate the risk of possible insolvency of the FHA
Insurance Fund as HUD continues its efforts to increase FHA’s capital reserve ratio to meet the
Congressionally mandated threshold of two percent.ii The final regulation marks the most recent
example of HUD’s renewed emphasis on the safety and soundness of the FHA loan program and its
efforts to transfer the risks associated with FHA-insured loans from the Department, and thus the
American taxpayer, to FHA-approved mortgagees, particularly those participating in the LI program.

This client alert summarizes the provisions of the final regulation and provides our observations as to
how the final regulatory changes will impact lenders that choose to continue to participate in FHA’s
LI program.

Please see full alert below for more information.

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