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Fitch taps brakes on fully digital mortgage revolution

Ratings agency says several technological, legal hurdles remain

The push towards the industry-wide usage of a completely digital mortgage seemingly took a big step forward last month when Ginnie Mae, the government agency that issues mortgage bonds backed by Federal Housing Administration or Department of Veterans Affairs loans, said it was moving forward with a pilot to accept eNotes (electronic promissory notes).

But, a new report from Fitch Ratings suggests that widespread acceptance of a fully digital mortgage (or eMortgage) may be many years away.

In recent years, numerous lenders digitized the front-end of the mortgage process, the mortgage application, led by Quicken Loans’ Rocket Mortgage and the like.

But there are still several substantial impediments that need to be addressed in order to shift the entire mortgage from a paper-intensive process to a digital one.

One of the main issues preventing the full digitization of the mortgage process was the use and acceptance of electronic promissory notes, also called eNotes. An eNote is an electronic version of a promissory note, the legal record of the obligation to repay the mortgage.

Traditionally, the promissory note was a paper document, but a move towards digitization in the mortgage business as a whole led to a rise in digital promissory notes.

But it’s not as simple as having a digital promissory note. The eNote also needs to be stored in a way that ensures it has the same legal enforceability as a paper document.

Despite those hurdles, data released earlier this year by MERSCORP shows that the number of eNotes added to the MERS eRegistry skyrocketed in the first quarter of this year; meaning fully digital mortgages are becoming more acceptable in the market.

And with massive companies like Wells Fargo and important agencies like Ginnie Mae jumping on the eMortgage bandwagon, it would seem that the entire industry would be moving in that same direction.

Not so fast, according to Fitch.

“Despite the industry’s enthusiasm for automation, widespread eMortgage adoption remains several years away, slowed by several obstacles,” Fitch Ratings said in a report. “While the mortgage industry focuses on borrower-facing automated technology, full eMortgages have remained elusive in the non-agency space. Originators and servicers will need to address concerns regarding enforceability, required technology, system security and showing borrower consent.”

Fitch notes that the government-sponsored enterprises (Fannie Mae and Freddie Mac) are among the most active in the eMortgage space, having developed a “full framework” to accept eMortgages.

According to Fitch, this includes the use of the MERS eRegistry to track loan transfers; lists of approved vendors for electronic closing systems and vaults; and specific representation and warranty requirements.

But, as Fitch notes, the process only functions within the counties and states that have the laws and infrastructure to support eMortgages, including electronic notarization.

And not all counties and states currently support eMortgage technology. According to Fitch, approximately 30 states and 60% of counties in the U.S. can currently support eMortgages.

Fitch said that it expects eMortgages to continue to grow in popularity, but said there are still many other issues that need to be addressed before an eMortgage becomes the industry standard.

“Some legal precedents have been established for eNotes based on a limited number of court cases,” Fitch notes. “In these cases, the eNote holder used the MERS eRegistry, provided electronic note affidavits and showed the integrity of the electronic vaults storing eNotes in order to establish standing in foreclosure.”

Additionally, if the underlying mortgages are to be included in residential mortgage-backed security, Fitch states it “critical that timelines in an eMortgage foreclosure are comparable to paper mortgages so as not to pose any incremental losses in the event of default.”

Adoption of eMortgage technology has also been slow in the non-agency space, as Fitch notes there are only a small number of originators and servicers that have the technology to support eMortgages.

As for why adoption has been slow, Fitch states that the cost to develop or acquire the technology required to originate, process and store eMortgages has been a “primary deterrent.”

Another potential legal and technical headache is a scenario in which a digital mortgage document is altered after the loan has closed. The advantage of a paper document there is that it is a legally enforceable document that loses its enforceability should it be changed.

A digital document could theoretically be changed without the borrower or a court ever knowing or having proof of the original document’s contents.

That’s where blockchain technology could come into play, as documents on a blockchain cannot be altered without others on the same network being notified to the changes.

“The security of the required technology is a crucial point to ensure eNotes have not been altered and support the holder’s ability to foreclose,” Fitch notes. “Fitch’s review process of proprietary and vendor-managed system security would be in line with the existing reviews of technology and vendors used in origination and servicing. This would include system demonstrations and a review of controls in place to prevent tampering of eNotes.”

While there are still many issues standing in the way of widespread use of eMortgages, Fitch suggests that there are real advantages on all sides of the mortgage transaction should the industry figure out a way to clear all those hurdles.

“While obstacles exist for eMortgages, the technology promises faster closing times, decreased closing costs, instant document delivery and ease of note transfers,” Fitch notes.

“Although only a small percentage of GSE production currently uses this technology, the driver for increased operational efficiency is expected to pressure greater acceptance across the industry,” Fitch concludes. “The electronic process implemented by eMortgages could be readily used by banks and other institutions that seek to employ distributed-ledger technology in mortgage origination and securitization.”

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