Mortgage lending has taken some serious blows in the last 12 months, but there is still plenty of purchasing and refinancing activity taking place. Yes, the Mortgage Bankers Association has forecast that loan origination volumes will decline by at least 15% in 2008, mostly due to the complete evaporation of subprime and Alt-A markets. And yes, the overall mortgage industry is in the midst of a painful contraction, as the lack of volume has starved off thousands of brokers and lenders.

But amidst all the gloom, there is one bright spot that is offering lenders a real opportunity for growth. Federal Housing Administration (FHA) lending is experiencing a renaissance that is looked upon as a vital solution to the current mortgage crisis. As a result, many small and mid-tier lenders have fully embraced FHA lending as a core strategy and are using it to expand their market share.

Recent statistics have shown that there is considerable demand for FHA products. The Department of Housing and Urban Development (HUD) has updated the program with new policies that make FHA lending more appealing to lenders. Although the FHA lender approval process is more stringent and resource-intensive than lenders are used to, the sheer growth potential of FHA has convinced many to make the commitment. What these lenders are discovering, however, is that the real challenge begins once the FHA approval process ends.

A key problem with FHA lending is the lack of originator familiarity with the product. Having the resources to support FHA lending is irrelevant if originators are unable to identify qualified borrowers at the point of sale. Given that the majority of today’s originators entered the industry during the subprime boom, it will come as no surprise that most have never originated a FHA loan. This lack of experience can result in greater fallout from mistakes made during the loan qualification and pricing process, leading to wasted resources and fewer funded loans. In today’s low-margin environment, lenders can ill afford these mistakes before opportunity costs irreversibly damage their bottom lines.

To help alleviate this problem, FHA provides originators with an automated tool to check borrowers for FHA eligibility. The FHA Technology Open To Approved Lenders (TOTAL) Scorecard system is a tool that is integrated with Fannie Mae’s Desktop Underwriter (DU) and Freddie Mac’s Loan Prospector (LP) automated underwriting (AU) systems. Originators submit credit report, loan and borrower information into DU and LP and can opt to run their file through the TOTAL Scorecard system.

TOTAL performs a check for creditworthiness and then relies on DU or LP to produce the underwriting eligibility result. Because most originators are already familiar with DU and LP, using TOTAL does not present a large barrier to FHA product adoption.

What lenders and originators fail to realize, however, is that TOTAL Scorecard and a DU or LP decision only addresses eligibility for FHA insurance. It does not determine whether an FHA loan can be sold to the ultimate funder of the loan. For that, borrowers must pass through an additional set of investor-specific guidelines.

Although not nearly as extensive or complex, investor FHA guidelines are similar to those of top-grade subprime products. They typically perform another review of a borrower’s credit strength by analyzing FICO scores, derogatory information and mortgage lates. Because originators need to be trained on these guidelines, this investor-level eligibility check creates a process bottleneck that can increase the incidence of error.

Cost is another factor that can make FHA less appealing to both originators and lenders. In order to run a file through TOTAL Scorecard via Fannie Mae or Freddie Mac, originators and lenders pay a fee for a decision. This cost is applied whether the file is approved, denied or referred. While the cost per file is not a huge expense, it can certainly add up when you consider that only a fraction of submitted loan files result in an FHA approval.

For a lender that relies on originators to make its FHA strategy a success, the training and cost prerequisites can significantly impede its progress. Remember, most originators are children of the lucrative, stated-income subprime era. Asking them to originate a product that requires more documentation and doesn’t offer nearly the same level of compensation can be a hard sell. Adding process barriers such as guideline checking and cash out of hand can result in outright protest against the product.

An outsider advantage

Luckily, technology can provide lenders with a solution that addresses these issues. Private-label AU systems have the ability to bridge the gap between FHA approval and investor acceptance by automating the additional guidelines that investors require for loan approval. This step reduces the imperative for an originator to retain extensive investor guideline knowledge, resulting in faster eligibility decisions and reduced incidence of error.

Private-label AU systems that can generate pricing offer another benefit of eliminating the need to reference rate sheets. The time and effort saved by use of a private-label AU system allows originators to focus on acquiring new business and generating additional volume for the lender.

Private-label AU systems can also indicate up front whether a TOTAL Scorecard submission is even necessary. Originators can perform an initial check of FHA and investor guideline approval prior to sending the file through TOTAL Scorecard and DU or LP, saving a considerable amount of time and money.

For those files that indicate FHA eligibility, private-label AU systems can even make it easy for originators to obtain an FHA endorsement by providing a direct integration to DU or LP, removing the step of having to manually enter their Web sites and re-key the loan information.

From an originator standpoint, private-label AU systems represent a convenient, one-stop shopping experience. The systems allow them to input borrower information at one time and receive an eligibility response across all loan product types, be it conforming, nonconforming or FHA. As a result, originators who are unfamiliar with FHA lending are less likely to allow a potential loan to walk out the door, and lenders will see their overall volumes increase as they capture more FHA lending opportunities.

More importantly, private-label AU systems create a network effect that improves all production efforts downstream from the origination process. Loan submissions that have been accurately vetted by a private-label AU system will fill the production pipeline with loans that have a much higher chance of closing. This improvement allows underwriters, processors and other production staff to focus their efforts on loans that will result in revenue.

The productivity savings generated by an AU system can allow lenders to lower their fees and enhance their competitiveness. And as lenders grow, they can use their private-label AU system as a recruiting tool to attract top-producing talent to add to their staff.

But making the decision to utilize a private-label AU system creates challenges of its own. Not all private-label AU systems are created equally, so lenders need to be aware of technological differences that can affect the quality of an AU decision.

Because most investor-specific FHA guidelines are driven primarily by credit data, it is essential that a private-label AU system has the ability to read a borrower’s credit report and utilize those data to determine loan qualification and pricing. Interfacing with credit vendors and parsing out the credit data is a must in order to obtain an accurate decision on investor acceptance.

Performance of a private-label AU system will also be heavily dependent on the provision of FHA and investor guidelines that are detailed and current. Today’s lending environment is extremely fluid, and FHA is the subject of current legislation debates that will undoubtedly change aspects of its eligibility criteria. Any lenders that choose the private-label AU system route must monitor these changes carefully, and they must maintain the facility to deploy these changes in a timely manner. Ideally, a private-label AU system vendor would provide these guideline updates on a managed basis, eliminating the need for the lender to shoulder this responsibility internally.

There’s no doubt that FHA presents a real opportunity for lenders to grab market share in a turbulent lending environment. Successful FHA implementation requires careful management over the origination process. By utilizing a private-label AU system in conjunction with FHA TOTAL Scorecard, lenders can gain an edge over competitors by shortening their time to market and lowering overall acquisition costs.