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   ARTICLE   |   From Scotsman Guide Residential Edition   |   May 2016

Yes, We Can Say ‘Yes’

The time is right for underwriters to approve mortgage applications more often

There is normally a healthy tug of war in the mortgage industry between loan originators and underwriters. Each loan deal brings a lot of pulling back and forth,  with one side eventually winning. The originators are pulling for a “yes” while underwriters are meticulously evaluating applications and sometimes saying “no.”

That’s certainly not a bad thing, of course. It benefits no one if originators are pursuing loan deals regardless of the applicants’ credit problems or property issues. We’ve already seen where that can lead. In fact, we are still paying the price for it — and that includes overly restrictive credit. Responsible originators don’t want to go back to the bad old days, either.

There are, however, a lot more things underwriters can do now to safely open up the borrower pool. It’s a widely held belief that credit today is more restrictive than it needs to be. A recent report confirms that belief and puts a number on how many good borrowers have been turned away by mortgage lenders.

The Urban Institute, a public policy research center based in Washington, published a report this past January indicating that between 2009 and 2014 the mortgage industry could have made loans to more than 5 million additional borrowers — and done so safely — if it had used the same underwriting standards that were in use in 2001, well before the mortgage crisis occurred.

Laurie Goodman, director of the Institute’s Housing Finance Policy Center, said lenders’ unwillingness to safely ease credit is holding back a recovery in mortgages and the broader economy. Anybody who’s had to jump through hoops only to be turned down for a loan can agree with that statement. Underwriters see it every day.

Taking the easy route

There are several reasons why many lenders are turning down people they gladly accepted before without any problems, but credit risk doesn’t appear to be one of them. Many lenders would prefer to turn away business rather than do a little extra due diligence to help more prospective borrowers.

Since the advent of automated loan-underwriting systems, many companies have relied solely on these engines and lost the art of truly understanding credit risk. Underwriting should be just as much about saying yes to acceptable credit risks — and pricing for them — as it is about saying no.

By relying too heavily — in some cases, exclusively — on automated underwriting, many lenders have denied loans to otherwise creditworthy borrowers. In the process, they have not only reduced their own new business, but failed to help people achieve the American dream of homeownership, which is why this business exists.

These automated systems certainly have a role to play and are responsible for some of the recent improvement in mortgage credit quality. But an overreliance on these systems also can lead to a sweeping denial of credit to many otherwise credit-worthy borrowers.

Underwriting needs to go back to the basics of evaluating credit through a thorough understanding of the loan application and become less dependent on automated-underwriting systems. The old adage of determining the borrower’s willingness and capacity to repay is critical to accepting a 620 FICO credit score versus rubber-stamping an arbitrary denial.

Avoid the stereotypes

Evidence of unreasonably tight credit standards can be seen firsthand in the market for mortgage loans guaranteed by the U.S. Department of Veterans Affairs (VA). According to Ellie Mae’s January 2016 Origination Insight Report, the closing rate on VA refinance loans was 45 percent, which was by far the lowest of any loan type Ellie Mae tracks.

Fortunately, some loosening of credit in the mortgage business has occurred lately.

By contrast, the closing rate on VA-backed home-purchase loans was almost 75 percent, the highest of any loan type. Yet, other things being equal, refis should be less risky, not more — at least in the VA market.

The bulk of VA purchase loans are made to active-duty military personnel, who tend to have almost no equity and lower FICO scores because of their young age and multiple deployments — factors that make it extremely difficult to maintain a good credit rating. By contrast, the typical VA refi customer tends to be older, retired, has more sources of income and has more home equity, but also more debt.

Many lenders shy away from these loans because they don’t understand how to underwrite credit for potential risk. Many of them believe that lending to veterans is too risky because they have bought into negative stereotypes about this group, or their underwriting systems deny loans arbitrarily without digging deeper to find out whether these applicants are genuinely creditworthy.

According to recent studies by the U.S. Census Bureau and others, however, veterans are, in fact, better credit risks than the general population. They are more highly educated, make more money and have better benefits, yet many of them find themselves at the mercy of a computer software program.

The simple truth is, lenders can’t rely solely on these automated systems to make definitive yes-or-no decisions — not unless they are satisfied in denying credit to people who can really use it and use it responsibly. It’s also the right thing to do.

Remain vigilant

Lenders should not be lowering their guard. On the contrary, underwriters can’t afford to be relaxed about credit risk. The risk of foreclosure, although greatly reduced from its peak, is still with us.

RealtyTrac found that foreclosure filings fell 3 percent in 2015 to a nine-year low, but there are still big pockets where defaults are surging. Indeed, nearly half of the states showed an increase in foreclosure filings last year — including Massachusetts, New York and Texas — as did six of the 20 largest metro areas, including Boston, St. Louis, Dallas, Detroit, New York and Houston. Bank repossessions, meanwhile, increased for the first time in four years, climbing by 38 percent over 2014.

At the same time, the amount of time it takes for a loan to go through foreclosure takes way longer than it used to, an average of 629 days nationally — and more than 1,000 days in six states, including some big homeowner states like New Jersey, New York and Florida.

Needless to say, the longer the foreclosure process drags on, the more costly it is for loan servicers. Servicers are still required to forward principal and interest payments to the investors who own the loans — even if the borrower isn’t paying the mortgage — while the property makes its way slowly through the process until the foreclosure is resolved or cured.

Then there is the cost of maintaining these properties to keep them in a sellable condition, plus the risk of deteriorating market values, either property-specific or because of general market trends. Nevertheless, many of these loans were made well before the mortgage crisis.

Approaching change

Fortunately, some loosening of credit in the mortgage business has occurred lately. According to Ellie Mae, the average FICO score on all closed loans dropped to 719 in January, down 12 points from a year earlier — and its lowest level since the company began tracking this metric more than four years ago.

Some news outlets have played that up as another credit crisis in the making, but it is more likely a sign that market conditions are finally starting to return to normal. Likewise, a recent report from Equifax found that so-called subprime mortgage volume — loans to people with credit scores of 620 or below — jumped 45 percent during the first 10 months of last year, compared to the same period in 2014.

Amy Crews Cutts, Equifax’s chief economist, said “lenders are focusing more attention on evaluating consumers’ ability to repay.” She noted that lenders are using tools to “more accurately vet subprime borrowers much earlier in the origination process.”

•  •  •

Lenders certainly shouldn’t be opening the floodgates to all borrowers, but they also should not be erecting walls to keep everyone but the most pristine borrowers out. In fact, responsible underwriting that says “yes” more often can be accomplished. It just takes a little extra effort. It’s not only good for loan originators. It’s good for consumers and the entire economy as well.


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