Improving Underwriting Will Mean Making Inclusive Automated Models
Editor's Note: Second of two parts. Read the first part here.
The nuance involved in originating mortgages to borrowers with nontraditional credit profiles often forces lenders to rely on manual underwriting. But these methods cost more and lack efficiency, creating the need for a more inclusive automated solution.
At New American Funding, which lends to many Hispanic borrowers, the company's president Patricia Arvielo noticed that loan officers serving this demographic — many of them Latino or Latina themselves — were encountering major hurdles when their loans went to underwriting.
"They were getting caught in the underwriting by an underwriter who wasn't culturally aware," Arvielo said.
To remedy this, Arvielo "halted the way we were doing business" and created a separate team of 20 experienced underwriters. These individuals were familiar with the nuances of Hispanic borrowers and now manually underwrite these loans.
"They're more seasoned underwriters that have seen these cultural nuances," Arvielo said. "I rarely now get a Latino loan agent stuck in underwriting."
In many ways, Arvielo's strategy resembles the process at many larger lenders. At Fifth Third Bancorp, loans that cannot be processed through an automatic underwriting system, often due to a borrower's nontraditional credit background, are elevated to an exception desk, said Edward Robinson, senior vice president and head of mortgage at Fifth Third.
This group of underwriters evaluates these loans to determine whether Fifth Third is in a position to take on the risk involved. In some cases, loans even make their way to Robinson's office if the exception desk cannot reach a decision.
"We have an exception desk that is committed 100% to making sure that as we get folks that are on the fringe or below where our automated tools would allow, there's a desk and a policy in which we can underwrite them," Robinson said.
"And if it doesn't even get approved by the exception desk, they can elevate it to me and I can handle it with my capital markets team," he added.
New American services its loans and holds nearly all of its originations in portfolio, allowing it to monitor pressure points and better understand potential warning signs for default.
"I'm able to look at the delinquencies in our book and begin to start peeling back the onion," Arvielo said. "I can see which borrowers are in default and why they are in default."
By holding onto the loans it originates, New American — which Arvielo said boasts a 0.06% 90-day delinquency rate in its $17 billion servicing portfolio — can more easily expand its credit box.
While manual underwriting and balance sheet lending alleviate many of the issues regarding lending to underserved borrowers, they are far from a panacea. As a result, the number of lenders able and willing to tap into these segments remains limited.
For starters, manual underwriting is a costly and time-consuming process. At New American Funding, underwriters devoted to borrowers with nontraditional credit background only get through two loans per day, compared to a workload of four to six loans per day that an underwriter can manage using automation.
"We have to go back to borrowers several times for receipts, trailing the funds," Arvielo said. "It's difficult."
Many lenders also lack staff with the talent to handle the complexities of manual underwriting, particularly given that many younger underwriters have only ever operated in an automated environment.
"There are not a lot of good, solid manual underwriters left" following the financial crisis, Altavera Mortgage Services President and CEO Brian Simons said.
Where portfolio lending is concerned, there is a higher amount of risk involved. Banks are limited by regulations in the amount of such risk they can take on, and nonbank lenders must have the funds to be able to keep loans on their balance sheet.
Nonbank lenders are "afforded the ability to do things that I can't," Robinson said.
Steps are being made to alleviate the issues involved with both manual underwriting and portfolio lending. Fannie Mae, which has long offered manual underwriting for nontraditional borrowers, recently introduced a new process for underwriting these loans through its automated underwriting system, Desktop Underwriter.
Beginning with the latest edition of Desktop Underwriter released in September, lenders can now underwrite these loans through a nominally automated process.
"Although we have a minimum credit score requirement, DU completes a direct assessment of the borrower's credit history," said Jude Landis, vice president of single family credit policy and risk management at Fannie Mae. "This allows us to be more flexible and directly assess credit in a way that makes the whole conversation about credit scores less urgent for us."
Lenders first submit information to meet Desktop Underwriter eligibility criteria, including loan limits, a loan-to-value ratio of no more than 90% and a debt-to-income ratio of less than 40%. If an approval recommendation is received, the lender must document a payment history for the borrower with at least two nontraditional credit sources, including at least one that is housing-related, such as rental payments. If a borrower does not meet the eligibility criteria, the loan can still be manually underwritten to receive approval.
"The innovation of being able to submit loans through Desktop Underwriter is so important," said Deborah Momsen-Hudson, director of secondary market lending at Self-Help Credit Union in Durham, N.C.
But Fannie Mae's offering isn't perfect. Indeed, it is not completely automated, and adoption could be an issue.
"People still talk about nontraditional mortgages with 2007 and 2008 sitting in their minds," Simons said.
And the program still presents restraints or requirements that may prove problematic for some borrowers, Arvielo said.
"I like to remain positive about all changes or enhancements that may help LMI borrowers access homeownership, [but] this particular program is too strict with the down payment requirements and DTI," Arvielo said.