Detecting Undisclosed Borrower Debt in Mortgage Lending
The financial crisis negatively affected both consumers and lenders in terms of the housing bust and subsequent rise in mortgage loan delinquencies, which eventually led to a dramatic change in mortgage underwriting.
Today, many mortgage borrowers are willing to disclose their debts when it comes time to apply for a mortgage application. However, fraud is still existent during the “quiet period” between when an original credit file is pulled and the closing of a loan.
Because fraud is a prevalent issue, lenders need to monitor this time period very closely to lower their overall risk during the underwriting process.
“Transparency is imperative to the loan process and many lenders simply do not have the tools in place to effectively monitor borrower activity once the original credit file pull occurs,” said Greg Holmes, national director of sales and marketing for Credit Plus, Salisbury, Md.
According to an Equifax white paper titled “Listening Closely During the Quiet Period,” almost one-fifth of all mortgage borrowers, including those with high credit scores and debt-to-income ratios, apply for at least one new trade line during this quiet period.
At the same time, these borrowers are unaware of how this new “undisclosed debt” impacts their ability to qualify for their mortgage.
Equifax said an average 14% of mortgage applicants obtained new debt during the quiet period. For some lenders, this figure was as high as 40%. The average monthly payment of this new undisclosed debt was $251.
Also, 36% of borrowers who assumed one new trade line of undisclosed debt during the quiet period had a debt-to-income increase of 3% or more. Individuals who opened additional trade lines are likely to increase their DTI ratios by another 3% or more, Equifax said. Furthermore, those who opened three new trade lines, their DTI then jumped to 79%.
“For many borrowers, purchasing a new home also requires them to acquire new home furnishings, such as curtains, bedding and throw rugs,” Equifax said in the white paper. “But during the quiet period, borrowers’ lives go on. They continue to buy gas for their cars, eat out, and buy new clothing using credit cards.”
Meanwhile, for lenders, undisclosed borrower debt that is incurred during the loan quiet period presents a real risk too because a 3% or more increase in borrower DTI can result in expensive loan repurchase demands by the secondary market or penalties by regulator, including Fannie Mae, Freddie Mac, investors in private-label, residential mortgage-backed securities, and the Federal Housing Finance Agency.
In its most recent fraud findings statistics report, the percentage of new liability for Fannie Mae mortgage originations misrepresentations was 46% of all loans in 2011 and 2012. This is up drastically from 27% of liability experienced in 2010 for all of the government-sponsored enterprises’ loans.
“Alarmed by borrowers defaulting before making a single payment, the agencies have shifted the burden of responsibility to lenders, although the agencies have not mandated how lenders should perform undisclosed debt monitoring,” Equifax said.
To mitigate risk and identify undisclosed borrower debt, many lenders often pull a credit report immediately prior to loan closing to ensure that there is no new debt to delay or terminate the mortgage deal. But this method has some major flaws.
First, both the lender and borrower are unaware that there is a problem until a few days or hours before the scheduled loan closing. Secondly, last-minute documentation requirements are inefficient and can increase lender costs while increasing the likelihood of errors.
Rather than relying on a snapshot of borrower credit behavior at application and at closing, efficient lenders are looking to improve the process by continuously monitoring credit inquiries as well as new trade line placements and new monthly payments as they occur during the underwriting process.
Therefore, Equifax created a fraud prevention tool called undisclosed debt monitoring that was developed to help lenders meet Fannie Mae’s Loan Quality Initiative recommendations and check borrower credit activity during the processing of a mortgage. The tool offers users continuous monitoring and daily proactive alerts on potential risks for a borrower.
Equifax determined that the average borrower who opens a new trade line does so 28 days prior to closing. So, for a lender to identify a 3% or more change in debt-to-income earlier in the underwriting process, they can meet with the borrower and take the necessary steps to either change the loan terms, gather additional documentation needed for investors, or determine another resolution before the borrower gets to the closing period.
“With early warning, the lender can proactively discuss the impact of the debt with the borrower, obtain additional documentation needed for the secondary market, and/or change the terms of the loan,” said the Atlanta-based information solutions provider.
Because Equifax’s undisclosed debt monitoring solution streamlines mortgage operations while reducing risk, Holmes decided to offer this tool to all 6,000 of his customers.
“Our customers who utilize this service will now be prepared to communicate with borrowers regarding specific activities detected during the mortgage process, increase their operational efficiency, and significantly reduce the costs associated with repurchasing loans,” Holmes told National Mortgage News in an interview. “This innovative tool is a pass-through route for mortgage professionals and consumers to detect possible fraud weeks before the closing process. The product helps lenders mitigate overall risk and remain efficient throughout the entire underwriting process.”