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The intricate art of today's mortgage underwriting.

Mortgage underwriting continues to change. Once too loose, then perhaps too tight, it now may be inching back closer to middle ground. [paragraph]But there's also little doubt, in most cases, that the underwriting process is being done more thoroughly, with many more steps required of the underwriters themselves. This is especially the case as more underwriting is done at least partly manually. And FICO[R] scores by themselves are becoming less determinative. [paragraph] "Over the last two years, underwriting has definitely changed from what it was five or 10 years ago, with all the QM [qualified mortgage] restrictions [around] the ability to repay. That's where a lot has happened," says Donald J. Frommeyer, a loan originator at Mortgage Services III LLC (MSI), Indianapolis, and chief executive officer and immediate past president of the National Association of Mortgage Brokers (NAMB), Washington, D.C. [paragraph] "But for the most part, I don't know if underwriting has gotten better or worse--but it's gotten different," says Frommeyer.

"Now, some lenders spend a lot of time wanting to look more at bank statements, wanting to know more about employment. It's just a difference in the lender. I still think they're making good aggressive decisions on underwriting. But they're all striving for that ability to repay and making sure customers fall within the guidelines."

"Just like anything, there's a pendulum," explains Mat Ishbia, vice president, marketing, at Troy, Michigan-based United Wholesale Mortgage. "It [underwriting] was way too loose, and some rules and regulations were put in place and underwriters put some overlays and protective things in place.... Now it's coming back to the middle, where it should be, where it's a little more reasonable."

Underwriting, with increased emphasis on borrower creditworthiness, often is no longer being left solely to automated underwriting (AU) systems, even when conventional mortgages are being underwritten. There's increased use of manual underwriting, something that the Federal Housing Administration (FHA) has increasingly pushed, including when Department of Housing and Urban Development-approved (HUD-approved) housing counseling is tapped by FHA borrowers.

"Our message to lenders is that they absolutely ought to consider whether a borrower has undergone housing counseling, because everybody knows, and we've done studies on this--borrowers that take advantage of housing counseling perform much better than those who do not," says FHA spokesperson Brian Sullivan in an interview with Mortgage Banking.

"From a risk perspective, that's a good thing," he says. "However, we wouldn't go so far as to say that housing counseling in and of itself would overcome financial material deficiencies in a loan application. Whether or not it makes a difference in saying yes or no to these loan applications would be judged on a case-by-case basis, applying our new manual underwriting standards."

Sullivan adds, "Broadly speaking, housing counseling is relevant but it may not necessarily overcome material deficiencies in the application."

"There's been a lot of sloppy underwriting," maintains Kyle G. Schultz, vice president of mortgage operations at Irving, Texas-based zIngenuity Inc., which provides contract underwriting, underwriting training, underwriting-hiring advice and other services to smaller lenders.

"Underwriters lost their responsibility in the underwriting process. I think that everyone was relying on inputting data into automated underwriting systems without a complete understanding of why they needed to keep validating it."

What makes a good underwriter

"From what we're seeing in terms of underwriter applications, the people we're coming across who are applying [for jobs] really don't have the depth of experience we're looking for.

Underwriters who were really just junior underwriters and were only part of the process are the ones kind of getting weeded out," he says.

They may have been called underwriters, but they really were nothing more than "income-verification clerks," he says.

When seeking out underwriters for zIngenuity's clients, Schultz explains, he seeks candidates with a range of experience with different loan types and different lender types, because "quality is really driven by where people worked and whether they've seen lots of different types of loans," he says.

"There's a stratification process that's going on," Schultz says. "Lenders are being more focused on who they're letting do the more complex work, but at the same time there's probably a leveraging up with talent and getting poor performers out of the process based on quality results."

In the struggle to find underwriters who have been trained to understand specific types of loans, whether conventional or specialties such as self-employed borrowers, mortgage brokers now look to specific mortgage companies or specific underwriters within a company for placing their loans.

"There are certain lenders we know that understand our sophisticated borrowers. They have some flexibility and understand complex borrowers," says Gloria Schulman, founder of Beverly Hills, California-based CenTek Capital Group, which specializes in jumbo loans to self-employed borrowers.

Also, at these firms, she says, "Some underwriters are more sophisticated than others." And it is to these specific underwriters that CenTek's loan packages are sent.

Frommeyer says he chooses lenders based on what their underwriters do particularly well.

"We have certain companies that do VAs [Department of Veterans Affairs loans] really well, certain companies that do FHAs really well and certain companies that do conventional business really well," he points out, noting that this means underwriters at these companies are experienced at underwriting those loan types.

Still other companies and their underwriters are especially good at handling mortgages for first-time homebuyers, which often requires finding alternative credit, he adds.

Sending loans to the appropriate companies and their underwriters is a better and more successful option than sending all your loans to the same company, Frommeyer makes clear.

Different approaches for different lender types

The approaches and methodologies used by underwriters vary by the type of lender, explains Tisha D. Hartman, director of real estate lending at KeyPoint Credit Union, Santa Clara, California, and former senior forensic underwriter at zIngenuity.

The most conservative and stringent are the lenders that cater solely to the wholesale market, she says. While they may have a particular investor that has closed out a loan niche for them, the methodology behind the underwriting that goes into each decision is going to be a lot more strict, she explains.

At the opposite end of the spectrum, the lenders showing the most flexibility, she says, are the large banks and credit unions that are going to park some of their loans in their portfolios.

Schultz says the level of understanding required of underwriters who handle such complex loans as jumbos and those made to self-employed borrowers is "critical and [it] really demands more time and demands a better-quality individual doing that work."

Wells Fargo Home Mortgage, Des Moines, Iowa, recognized the different skill sets required for underwriting complex portfolio loans, 30 percent of which are non-QM, and for underwriting QM agency, FHA and VA loans, when it established separate underwriting teams for each in the third quarter of 2013.

"It's a very separate group of underwriters that underwrite only portfolio loans and are located in only six locations across the country," says Allyson Knudsen, Wells Fargo's executive vice president and head of underwriting and production risk management, who is based in Minneapolis. "And we actually have a process where we have a panel review. Loans are brought to the panel to talk about why you would or would not want to put the loan on the balance sheet."

QM teams are also based in those six locations as well as in 11 QM-only underwriting locations, she says, and all their loans are manually underwritten after automated engines provide credit and ratio risk assessments.

In having two separate teams, Wells Fargo saw the difficulty of keeping up with the ever-changing underwriting knowledge required of each, even for conventional loans, she explains.

"Because agencies change their guidelines every day, those underwriters have to keep up with all the agency changes, and all the FHA and VA changes," Knudsen says. "So as clarifications, et cetera, are sent out, we want people to be able to absorb all that change. Same thing on the portfolio side: That they have expertise and judgment regarding our policies. In today's environment, it's [asking] a lot for somebody to wear multiple hats. We believe we'll have better execution across both if we separate them out."

The portfolio team has more flexibility in documentation requirements and the judgments they can make on such things as child support, alimony and percentage of income available for mortgage payments, Knudsen says.

Going beyond credit scores

Underwriting today requires obtaining and understanding more information about borrowers or, as some players describe it, more research and analysis.

Wells Fargo Home Mortgage no longer simply takes the middle of the three FICO scores, according to Knudsen.

"Today we use credit reports for our lending, and analyze and leverage those credit reports as opposed to just the score," she explains.

"The report tells you some things the score doesn't. We really looked at lowering our FICOs in a couple areas and then leveraging our underwriters' expertise to underwrite the credit that's on the credit report, because there are things you can determine today [about] why a score might be low. We want to make sure we're making a good decision and extending our credit to creditworthy borrowers even if [that borrower] might have a lower credit score."

KeyPoint Credit Union's Hartman says that as an underwriter, she has deviated many times from "what would be the standard protocol, because I have a greater understanding of what's behind the numbers and I can make an argument and present that to the end investor or to the agency and get them to buy off on it because I understand the methodology. So it's not always just about filling in the box--it's about really understanding what you're looking at and how that layers into the rest of the file."

Underwriting, especially manual underwriting, needs to be seen as both a science, with its guidelines and technology, and as an art as you "extract a lot of information about a person's lifestyle and turn that into something meaningful and then make a business lending decision," Hartman points out.

Whether underwriters are using an automated underwriting system or doing manual underwriting "makes a big difference, because sometimes something doesn't make sense on paper but when you get the story, it does [make sense]," says Sharmen Lane, director of education and a senior underwriting instructor at Loan Officer School, New York.

"It's almost like underwriters and loan officers need to be private investigators today," says Lane. "It's all about research. Everybody back in the day [before AU] used to do this."

She adds, "So sometimes if a loan makes good sense and you can back it up with documentation but it doesn't quite fit the box exactly perfect," you still may be able sell that loan.

Propensity to pay

Jon R. Daurio, chairman and chief executive officer of Nikkael Capital Corporation, Tustin, California, a new company that is targeting credit-scarred, low-FICO borrowers for refinance loans, says his company is ignoring FICO scores. Instead, after determining sufficient net disposable income, he says that Nikkael will look at propensity to pay, which, he maintains, many people have ignored.

"What is in the borrower's history that indicates that they have a propensity to make the payments? There are some people that have the ability to make the payment but then they'll decide not to make the payment," he says.

"We look at what caused the late payments. What actually is the borrower's story? And what actually happened in ensuring that that life event is unlikely to occur again or has been resolved? The only way to determine this is with manual underwriting," Daurio says.

His past experiences during a 20-year career, he adds, showed that "FICO was not a good indicator of whether a borrower was a good credit risk." As a result, he says, "I think people are getting more comfortable with making loans to people who have hiccups in their credit."

San Jose, California-based FICO has been actively making changes to its FICO scoring processes, beginning with the launch of FICO Score 8 in 2009. On Aug. 7, 2014, it announced that medical debts would be accounted for separately under the new FICO Score 9, differentiating medical from non-medical collection-agency accounts in order to be more predictive of a consumer's likelihood to repay a debt.

Broker Frommeyer says that medical debt has been a problem he has encountered with some borrowers with lower credit scores. "I think [with FICO] looking at it differently is going to help a lot," he predicts.

Adoption, however, is likely to be slow.

Adopting new scoring models

Freddie Mac, which does accept such newer models from the credit repositories as Equifax Beacon 5.0, Experian/Fair Isaac Risk Model V2 and TransUnion FICO Risk Score (Classic) 04-- two of which are required for all manually underwritten mortgages--is currently analyzing the impact of FICO 8 but has not begun on FICO 9, according to spokesman Brad German.

"Retooling the mortgage industry around a reformulated credit score is a complex undertaking," German points out, with all the players having to analyze any new score's impact on their systems, operations and ability to evaluate and price risk.

But many lenders and their underwriters, as well as the agencies and FHA and VA, already have begun to look differently at medical debt.

Houston-based BBVA Compass Bank, for example, uses "the guidelines for medical collections debt that have been set by such specific investors as Fannie Mae, FHA and VA, and consider the overall scope of the borrower's credit profile," according to Elliot Salzman, senior vice president and director of consumer policy and underwriting for BBVA Compass.

The bank also has made changes in its underwriting in order to follow QM guidelines, he says.

"We now follow Appendix Q for all QM originations, with government-sponsored enterprise [GSE] and/or government products as an exception," Salzman explains.

"We've also developed a broad portfolio of non-QM products. Additionally, we minimized the overlay on our FHA product, lowering our minimum score requirement to 580," he says.

A continuing underwriting issue, particularly with FHA mortgages, is the use of overlays.

The issue of overlays

KeyPoint Credit Union's Hartman says overlays that establish higher standards is one way for lenders to protect themselves from buybacks, should underwriting turn out to be inadequate. Overlays, she says, also provide more flexibility as to what investors loans can be sold.

"I think most lenders reacted [to the housing market collapse] by tightening lending standards and implementing significant overlays," says BBVA Compass' Salzman. "Since then, the industry has seen an easing of both, particularly with FHA loans."

Yet he admits that BBVA Compass "does have minimal overlays in our Federal Housing Administration products. They play an essential role in helping the bank mitigate potential risk."

But because these overlays, like the bank's loan guidelines, are proprietary, Salzman says he cannot provide specifics.

Wells Fargo, says Knudsen, used credit overlays back when it required higher credit scores for conventional mortgages. Now, she notes, "We are looking at all our overlays as a matter of course" to make sure the company provides "access to credit for all customers that are credit-ready."

That overlays might restrict loans to borrowers on the basis of race or national origin is a concern for FHA, says FHA spokesperson Sullivan. "These credit overlays might rise to unfair lending practices," he points out.

"We're trying to encourage lenders to move away from all these credit overlays, like a credit score higher than what our standards call for, that they're tacking on," he says.

"Even with our backing of the mortgage, lenders still may be reluctant," Sullivan admits. "We're trying to get them to overcome their shyness and get back to lending to these credit-qualified borrowers."

"Underwriting is going to be a constantly evolving thing for our world as we keep learning more about consumer behaviors and patterns and things like that," says Hartman. "It's going to be a continuing, ongoing evolutionary process for all lenders."

Jerry DeMuth is a Chicago-based freelance writer. He can be reached at
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Comment:The intricate art of today's mortgage underwriting.(COVER REPORT: PRODUCTION MANAGEMENT)
Author:DeMuth, Jerry
Publication:Mortgage Banking
Geographic Code:1U9CA
Date:Nov 1, 2014
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