An industry trade group says its members are facing hardship from buyback demands with “wildly disproportionate” penalties.

The Community Lenders of America is asking government-sponsored enterprises (GSEs) for indemnification as an alternative to their expensive buyback demands, reports National Mortgage News.

The trade group, which represents small to mid-sized community lenders, has made the request for performing loans with defects.

Those mortgage lenders claim that the GSEs’ have increased scrutiny for manufacturing errors. And they’re being forced to sell loans at steep discounts in the scratch-and-dent market, says the publication.

The group says it would be fairer to the lender to automatically offer indemnification on performing loans with defects. It would also be more efficient overall and provide more protection for consumers, it added.

The GSEs’ standard response in these cases is a buyback. But that’s become unsustainable for these lenders.

When rates jumped from around 3% to 6%, the losses from reselling the loans in the nonagency secondary market grew exponentially. The average member has been losing around 30% of the value of each loan. That represents an average loss of about $100,000 on a $335,000 loan. Historically, that loss would be around $20,000.

There are, of course, issues. The group says repurchased loans lose some consumer protections they’d have in a mortgage-backed security backed by the GSEs. But they’re still subject to the CFPB’s rules.

That’s not to say lender-servicers won’t take actions to help keep borrowers in their homes, the group said in a letter to the Federal Housing Finance Agency. But, it adds, if the GSEs remove the wrap, lenders may have no choice but to sell mortgages to opportunistic buyers on the scratch-and-dent market. That puts the borrower at risk because buyers motivated solely by profit may foreclose if the borrower stops making payments.

While the FHFA did not respond to National Mortgage News reporter Brad Finkelstein‘s request for comment, he did get input from former Mortgage Bankers Association President & CEO Dave Stevens.

Stevens, now CEO of Mountain Lakes Consulting, said it sounds like the GSEs are “kicking back literally anything with a defect.”

“By these actions, they’re only increasing their likelihood that these companies will fail,” he said. “Meanwhile, the GSEs are making billions of dollars. Something’s not right here.”

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