Fannie Mae released an updated Seller Guide that included a major change in its Home Affordable Refinance Program (HARP) rules yesterday.

Although most of the changes to the HARP guidelines had been previously announced, the elimination of the 'borrower ability to pay' clause is a "significant and unanticipated change that could have ramifications for the HARP program and realized speeds," according to a Barclays Capital report released this morning.

In the report, the bank explained what this clause means and how it has changed. 

Fannie Mae requires its lenders to follow certain underwriting guidelines and documentation procedures for loans that are delivered to it. Under the revised guidelines, the 'borrower ability to pay' clause is no longer an underwriting requirement.

Barclays analysts said that the prior Seller Guideline for HARP loans that are processed via the manual underwriting channel – or what is called Refi Plus – puts the burden on lenders to find out whether the borrower has 'a reasonable ability to repay the mortgage.' This assessment is based on data offered by borrowers and their payment history. It also requires that lenders verify and ensure that the borrower has a source of income.

Ability to pay has historically been measured using debt-to-income ratio. Although according to HARP guidelines, there was no DTI calculation or evaluation needed if the borrower's payment did not increase by over 20%, while a 45 DTI cap was applied otherwise, Barclays analysts explained.

They noted that  this is not a change that was announced together with the other HARP program revisions on Nov. 15. It seems like the GSE has taken into consideration subsequent lender feedback and incorporated this change into its guidelines.

Analysts said that this is a significant change because as part of relaxing and streamlining rep and warranty requirement for the HARP program, the GSEs have lessened or waived most of the underwriting requirements of traditional loans.

But, analysts  said that the 'ability to pay' guideline has continued to burden lenders with a subjective underwriting evaluation process that has rep and warranty risk.

Barclays analysts said that in their conversations with lenders this requirement has often been highlighted as one of the significant hurdles to HARP refinancing.

Lenders seem to think that the lack of clarity on what 'reasonable ability' precisely means can subject them to indemnification liability if the loan defaults. Though the GSEs have said that this clause ensures prudent underwriting judgment and the efficient choice between the HARP and the Home Affordable Modification Program or HAMP, lenders think this is a significant risk. 

The elimination of this clause takes away many of the remaining concerns regarding rep and warranty indemnification iin terms of HARP refinancings, analysts said. Lenders can now underwrite HARP loans looking at borrower credit based on a more straightforward standard – number of payments made. This considerably lessens the complexity in terms of the rep and warranty liabilities for these loans, Barclays analysts said. 

In terms of prepayments, Barclays analysts said that lenders that refinance HARP loans, especially through Fannie Mae's manual underwriting process, are now able underwrite loans on the basis of payment history and verbally verified income source. The removal of the subjective 'ability to pay' criteria could result in lenders becoming more comfortable with the potentially lower indemnification liabilities. This could lower the threshold for refinancing loans and lead to a boost in refis. 

However, analysts warned that some hurdles, including mortge insurance and the presence of second liens, still remain. It is also unclear also whether lenders have the ability or intent to pledge resources needed to ramp up the implementation of the HARP program.

Nevertheless, analysts think that removing the 'ability to pay' clause, when taken together with the other changes to underwriting criteria, can work to boost prepays more than was expected considering the initial changes to the HARP guidelines.

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