Chances are that if you’ve been around Federal Housing Administration lending for any amount of time you’ve heard the term, “compare ratio.”
But what, exactly, does that term mean and why is it important?
The FHA compare ratio is a metric used to assess the loan performance of a lender in a specific geography by comparing its default (90+ days delinquent) and claim rate to its peers in the same jurisdiction.
For example, if a lender has a default and claim rate for the state of Texas of 6% and the average default and claim rate for all lenders in the state is 3%, the lender’s compare ratio would be 200% for Texas. Accordingly, a compare ratio of 100% means that a lender has exactly the same loan performance as its peers in a given jurisdiction. Compare ratios are tabulated for both 1 year and 2 year periods.
The compare ratio is used for a variety of purposes both at the FHA and throughout the industry. It was first created for use in FHA’s Credit Watch Termination Initiative. Via this initiative, the FHA conducts quarterly reviews of the compare ratios of its approved lenders to identify those with 2 year compare ratios of 150% or higher.
Lenders with compare ratios at or above 200% may be subject to a 6 month termination of their origination authority in the geographic region in which their compare ratio exceeds 200%. As an added note, other metrics are also considered by the FHA when making a termination decision. Additionally, notice of these lenders’ termination is published in the Federal Register, making their poor loan performance public.
Over the years, however, the compare ratio has been adopted for other uses as well. The FHA also uses the compare ratio to evaluate the performance of lenders that participate in its Lender Insurance Program. The Lender Insurance Program permits participating lenders to endorse mortgages for FHA insurance without prior review by FHA. A lender participating in the Lender Insurance Program whose compare ratio rises to 150% or more may be liable for the suspension or termination of its Lender Insurance authority.
Outside of FHA, industry participants utilize the compare ratio as well. Most warehouse lenders evaluate a lender’s compare ratio before agreeing to extend a warehouse line, and continue to monitor the lender’s compare ratio on an ongoing basis to determine continued eligibility for the warehouse line.
Likewise, wholesale lenders consider the compare ratio of correspondents before entering into a wholesale agreement with them. These are just the most prominent uses of the compare ratio by industry participants, but there are numerous other entities that utilize the compare ratio to vet and monitor lenders. A lender’s ability to effectively manage its performance as measured by the compare ratio is crucial to its ability to thrive in today’s mortgage market.