Watering Down FRT Definition
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Definition of FRT simply does not reflect the majority of the mortgage lending environment…
So what exactly is a “federally related transaction”, or FRT for short?
Wait, that’s not the right question. Let’s start here: What is NOT an FRT?
It’s not a mortgage loan insured by the Federal Housing Administration. It’s not lending underpinned by the Department of Veterans’ Affairs home loan program. It certainly isn’t a loan that’s sold to a Government Sponsored Enterprise (or GSE), like Fannie Mae or Freddie Mac. Just considering a loan for sale to those two entities is enough to fall outside the scope of an FRT. And, of course, any loan beneath the $250,000 appraisal threshold amount.
Now that we’ve clearly stated what does NOT constitute an FRT, let’s answer the original question: An FRT is a mortgage loan whose total amount is above the $250,000 threshold, is not insured or guaranteed by a federal agency, and is not sold or contemplated for sale to a GSE such as Fannie or Freddie.
That doesn’t sound very “federally related”, does it? And more to the point, how many of these loans actually exist in the mortgage lending marketplace? The short answer to the second question is between 8-12% of all mortgage activity falls within the contours of an FRT. So what happened to the federal nexus with FRTs in the first place?
To answer that, one must look at the implementing regulations promulgated in 1994 by the federal banking agencies. Those rules created a number of exemptions from the definition on an FRT not for inherently nefarious reasons, but to address lenders’ concerns about a duplication of efforts when originating loans that were both considered FRTs under the original definition and also had to meet the requirements of either a federal insurance or guaranty program, or those of the secondary market as set by the GSEs. The exemptions were designed to make clear that where an agency or GSE had its own robust appraisal requirements, those would be controlling as they were (and still are) considered similar to the obligations imposed under Title XI of FIRREA.
As recently as 2010, the federal banking agencies emphasized that the 1994 exemptions only cover those transactions that otherwise meet the insurer/guarantor/GSE underwriting and appraisal requirements. This makes clear the point of the 1994 regulations – exemption does not mean waiver, but instead means a replacement regime exists that is no less rigorous than what Congress contemplated in Title XI in the first instance and can stand in the place of Title XI obligations.
No matter the intent of the federal banking agencies, though, there are unintended consequences that come with the 1994 exemptions. For starters, numerous state laws that followed FIRREA’s passage rely in part or in whole on the definition of a FRT to define who must have a license or certification, as well as the scope of a state’s enforcement program. So which definition is controlling for these purposes: The original definition as passed by Congress in 1989, or the one with exemptions under the 1994 regulations? This confusion has led state regulators to ask for clarification surrounding the matter, so they can either continue on with their program as designed or go to their legislature and seek the necessary technical corrections.
But the more troubling consequence of the 1994 exemptions is that they give federal agencies and, more pointedly, the GSEs an outsize amount of control over appraisal requirements for their purposes. In acting with FIRREA and in the wake of the savings and loan debacle of the 1980’s, Congress made two clear declarations to the lending community: First, that the value of the property on which they were making loans needed to be a primary factor in deciding whether to close a deal, and not a secondary paper for the file; and, Second, that those appraisals had to be performed by qualified professionals who followed standards. Even with the more recent housing finance crisis of the mid-2000s informing decisions in this arena, we’re seeing today a move by the GSEs to eliminate appraisals on a range of purchase money and refinance mortgages – loans that may likely fall within what Congress originally intended to capture as an FRT, but that was carved out in 1994.
Time will tell if this pivot winds up being a fulcrum for the next housing finance meltdown, but one thing is clear: The appraisal requirements that Congress intended to impose on mortgage lenders with FIRREA simply don’t exist anymore, between the watering down of the FRT definition and, just as critically, the fivefold increase in the appraisal threshold amount. By letting those with a direct financial interest in the transaction have the latitude to rewrite the rules as they see fit for business purposes, we lose sight of the very safety and soundness principles that are supposed to undergird the mortgage lending market in the first place – recognizing both its outsize influence on the economy as a whole, and the fact that buying a house is the single largest investment most Americans will ever make.
Conversations on how to find the healthy middle on appraisals are happening in Washington with growing regularity, as we try to get out of the constant regulatory/deregulatory swings that come with the boom-bust nature of the housing market. But it’s clear from any perspective that, as currently constituted, the definition of FRT simply does not reflect the majority of the mortgage lending environment.