BLOG VIEW: As we plowed through the early to mid-2000s, there were very few consumers who could not obtain mortgage financing one way or the other. Granted, the basic borrower qualification premise was completely thrown out the window because, as the thinking went, risk-based pricing could account for just about any potential risks associated with a mortgage loan.
Although there is merit to risk-based pricing, in its very basic existence, the intent and the actual application became two entirely different processes. Although it has only itself to blame, the industry provided a vehicle that enabled it to layer loan risk so thick that it actually created a completely false set of standards for what was considered a qualified mortgage loan.
Now, with Fannie Mae and Freddie Mac's first-time home buyer programs, we are witnessing the re-emergence of what was once the poster child for risky lending business: 97% loan-to-value (LTV) ratios as an option. Personally, I am cautiously optimistic about the future of these more accessible products – but this is, no doubt, a fitting time to reflect and focus on quality control (QC) strategies that are critical for responsible residential mortgage lending. With the proper risk management and audit tools, lenders can both maintain loan quality and take advantage of the business opportunity at hand.
Factoring in an organization's technology is key to evaluating its loan manufacturing process – now a critical QC perspective. For example, monitoring defect rates is a trackable process in every originator's workflow. This is further enhanced when lenders utilize technology in an advanced discretionary selection method through which loans carrying the highest-risk factors are selected for additional review.
If it were up to me, I would start my pre-funding process by conducting a 100% review on all 97% LTV loans. That would be standard operating procedure until such time as I could confirm that the manufacturing process produced a defect rate that eliminated the risk of originating loans ineligible for sale to Fannie Mae or Freddie Mac. As this risk is winnowed out, I would gradually begin to reduce the percentage of loans I was selecting for pre-funding review.
This tiered-down structure would rely heavily on technology and its ability to process data to accurately identify loans carrying the highest-risk factors based upon my organization's book of business. An organization's ability to adequately process loan-level data through technology, combined with access to improved industry data, is key to establishing a proper and accurate selection of loans for review.
Another item that comes to mind regarding the new 3% down payment loans is closely tied to the ability-to-repay (ATR) guidelines, and it speaks to why some high-LTV loans perform better than others, such as the Veterans Affairs' 100% LTV product. A documented problem with increased defaults of high-LTV loans can be tied directly to the layering of risk.
Frankly, it is my opinion that there is a potential hole in ATR as it applies to the regulations relating to the temporary transitional period. During this period, certain loans that are eligible for sale or guarantee by a government-sponsored enterprise (GSE) or are eligible under specified federal agencies' guarantees or insurance programs will be considered qualified mortgages (QMs) under a temporary definition. The loans must meet certain QM restrictions on loan features and points and fees, but they are not subject to a flat 43% (debt-to-income (DTI) limit.
My concern for this transition period is related to the treatment of childcare expenses, along with the non-requirement to assess a borrower's residual income. The childcare piece is most baffling because this can be a huge recurring expense for many families, and many of these borrowers fit into a target market that would qualify as a first-time home buyer. Three percent loans provide a much-needed reduction in home-buying capital, but when qualifying a first-time home buyer, can we responsibility omit a recurring monthly liability from our DTI calculations that could easily be $1,000 for two children? In some areas of the country, this could be the expense for one child.
For the sake of a quick numbers discussion, let's take a family of four with an annual gross income of $85,000 that qualifies through Desktop Underwriter (DU) with a 36% DTI ratio. If this family has a need for childcare, this $1,000 liability immediate pushes their true DTI to more than 50%. From my recent experience of reviewing thousands of post-closing audits, I have noticed a common qualifying practice, whereby the childcare expense is commonly omitted for any calculations of the borrowers' DTI when using DU.
As a lender, how will you instruct your underwriters to treat this type of situation? Would you elect to decline a loan that you know has an excessive DTI ratio or concern over the layered risk, even though it has a DU approval stating the loan has a 36% DTI?
But, I digress. What follows are three recommendations to achieve the highest loan quality with minimal struggle:
1. Consider increasing QC reviews – maybe to 100% of all loans with a 97% LTV.
2. Target pre-funding, post-funding and servicing audits to assure the manufacturing process has appropriately implemented all requirements of the GSEs.
3. Leverage technology, analytics and a trusted partner to prioritize areas of concern and process improvements.
And, you should not go it alone. Technology and analytics will give you the road map you need to improve manufacturing processes and reduce risk.
Phil McCall is chief operating officer of ACES Risk Management Corp. (ARMCO), a provider of audit and QC technology for the mortgage industry.
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