Lenders must address repurchase risk before they go bust

While buyback volumes remain well below their 2022 peak, they are still elevated compared to pre-pandemic levels. The added cost pours salt in the wound for credit unions, banks, and independent mortgage bankers, who are already recording average pre-tax losses of $534 per loan origination. This challenging environment, marked by high operating costs and low origination volumes, has pushed lenders to operate leaner than ever, as evidenced by reports from the Mortgage Bankers Association that independent mortgage bankers have reduced their sales and non-sales staff by 44% since 2022. Trimming headcount helps cut costs, but it also introduces capacity constraints and burnout — factors that heighten the risk of costly human errors.

In this context, the financial repercussions of mistakes are severe, with the specter of mortgage loan buybacks looming large for lenders who fail to manage risk proactively. In this environment, strategies to mitigate repurchase risk — through technology, precise quality control, and strong collaboration — are essential to avoid serious financial and reputational fallout.

The cost of a bad hand

When selling a loan, lenders provide legal assurances to the government-sponsored enterprises (GSEs) that guarantee the accuracy and completeness of the loan data, known as representations and warranties. These reps and warrants cover borrower income, employment, and property information. When lenders or their technology providers fail to maintain a high standard of data accuracy, loan buybacks increase.

Much as the flop is only revealed after the first bet in Texas hold’em poker, defects surface after a loan has been sold—and they can make or break profit margins. Mortgage loan buybacks, often referred to as repurchases, occur when a loan sold to an investor or GSE fails to meet the agreed-upon underwriting, legal, or regulatory standards. Whether the discrepancies are introduced by inefficient tech, underwriting errors that bypass quality control, faulty documentation, misrepresentation, or omissions, the GSEs can demand the lender repurchase the loan at its unpaid principal balance, resulting in significant financial losses that are only compounded by legal fees, reputational damage, and strained investor relationships that harm lenders’ future liquidity and market standing. 

Loan buybacks also harm investors by introducing volatility and diminishing returns. And though borrowers aren’t directly involved in the repurchase process, they often feel its ripple effects in the form of tightened standards, increased fees, or increased interest rates. Minority and first-time homebuyers are disproportionately impacted by this reduced access to affordable credit.

Don’t fold just yet

Rather than walking away from the table, lenders, tech providers, investors and the GSEs are seeking risk mitigation solutions. While technology providers focus on increasing data accuracy to help lenders effectively access reps and warrants relief, Fannie Mae and Freddie Mac have begun exploring alternatives to the traditional buyback process. Freddie Mac is testing a fee-based repurchase alternative through a pilot program that could significantly reduce costs for lenders when minor defects are found. Fannie Mae has taken steps to revive defect notifications for “potential” loan flaws pre-purchase, providing lenders with additional time to address errors without facing immediate repurchase demands. Such programs offer lenders alternative paths to resolve defects, lowering costs and reducing repurchase volumes.

Despite these developments, buyback costs remain a pressing problem for many lenders. In July, The Mortgage Collaborative, a cooperative network of independent mortgage companies, banks, and credit unions representing about 10% of U.S. total mortgage volume, announced the launch of a Repurchase Request Tracker enabling members to log every buyback demand. This data collection effort highlights the industry’s continuing concern and shows that repurchase requests are far from disappearing. Buybacks are most commonly driven by:

Loan defects: Inaccuracies related to borrower income, assets, or employment that weren’t caught during underwriting.

Documentation issues: Missing or inadequate documentation.

Fraud: Third-party or internal fraud is especially problematic, triggering immediate action from investors.

Underwriting errors: Loans that fail to meet GSE or investor standards, either due to oversight or systemic process issues.

What’s in the cards?

Over the past two years, repurchase volumes have trended downward, but recent data reveals that a resurgence may be on the horizon. In Q1 of 2024, critical defect rates across mortgage loans saw a modest increase, ending five consecutive quarters of decline. While low by historical standards, the rise was notable given the decreased volume of loan originations during the quarter. Income and employment data—the leading category for defects—showed significant improvement, but other areas saw troubling setbacks.

In Q2, Freddie Mac seller repurchases rose to $430 million—a 29.1% increase from Q1. By contrast, Fannie Mae sellers repurchased $268.5 million in noncompliant loans, marking a 27.7% decline in repurchases over the same period. This discrepancy is drawing attention in the industry, with one mortgage executive lamenting to HousingWire, “The repurchase problem with Freddie Mac has accelerated 10x. Our requests are up 100% month over month.” 

Stack your deck

Lenders have the tools at their disposal to minimize repurchase risk, but success requires proactive risk management strategies. There are three critical steps lenders need to take:

1) Start with Quality Control

The most effective way to combat buyback risk is by improving loan quality from the outset. Lenders must invest in stringent pre- and post-closing audits, conduct thorough staff training, and apply consistent underwriting standards. The rise in credit defects and compliance errors demonstrates that quality checking is essential. Automated compliance tools can also help lenders catch errors early, flag potential issues, and ensure that loans meet investor and GSE guidelines before they reach the market.

2) Leverage Automation to Stay Ahead

Lenders can use automated tools to validate dataand gain reps and warrants relief at the point of origination, significantly reducing repurchase risk. For example, reps and warrants on home value are waived for certain loans when the appraised value closely matches the estimate produced by the GSEs’ automated valuation model (AVM). 

Additionally, the GSEs will not enforce reps and warrants on assets, employment, or income if they are correctly validated through an approved service provider, such as Argyle. Checking the list of approved vendors for Fannie Mae and service providers for Freddie Mac is a good start, but lenders should note that even approved vendors vary widely in data accuracy, which in turn directly impacts the frequency with which reps and warrants relief is granted. Thus, rather than evaluate vendors only on their GSE approval status, lenders should ask how consistently a given technology actually results in repurchase risk mitigation. 

3) Foster Open Communication with Investors

Transparency and collaboration are key in managing repurchase risk. By maintaining open channels of communication with investors, lenders can better understand evolving expectations and avoid future buyback triggers. Partnering with third-party quality control providers can also help strengthen investor relationships. By providing objective oversight, ensuring loan quality at every stage of the process, lenders reduce the risk of reputational harm caused by repeated errors.

Go all in to reduce repurchase risk

Despite a downward trend in overall buybacks, the recent rise in critical defects shows that mortgage lenders cannot afford to be complacent. Mitigating repurchase risk requires a focused approach, combining proactive quality control, the latest technological tools, and strong investor relationships. Lenders may soon find relief from the financial burden of traditional repurchases through GSE buyback alternatives—but only if they maintain high loan quality standards. In a fast-paced market, there’s no room for hesitation—only proactive, strategic action will secure long-term success.

By John Hardesty, EVP of Mortgage, Argyle.

This column does not necessarily reflect the opinion of HousingWire’s editorial department and its owners.

To contact the editor responsible for this piece: [email protected].