Which one of these clients would you rather lend money to? Which one would you expect would pay a higher mortgage rate? Which loan is harder to get approved? Which loan is more likely to go into foreclosure?
Client A: This client is Joe Sixpack and a first time home buyer purchasing a $250,000 home in the West Podunck and has five percent to put down. However, a five percent down payment will only leave him with about $2000 in cash after closing, just barely enough to pay movers and maybe by some cleaning supplies at Wal-Mart. He has a 650 FICO score due to a number of late payments on cell phone and credit card bills over the years. His debt ratio is close to 54% which means more than half his income before taxes is going to pay the mortgage and other major debts. He also had a bankruptcy three years ago.
Client B: This client is Joe Ivy League and is buying a home for $600,000 and is putting 
10% down. After the down payment, he will have a little more $1.2 million in remaining in liquid reserves. The borrower works for a major investment bank and makes a base salary of $125,000 per year and has a year end bonus of at least an additional $150k. However, we can’t count the bonus income because he recently completed his MBA at arguably the best business school in the country so he hasn’t yet received his first year bonus payout although a five second Google search would show all kinds of well respected third party documentation (Wall Street Journal for example) of what first year investment banking associates can expect in total comp. His current home is listed for sale, but no offers so we have to count the carrying cost of the home. When counting the debt from the current home plus the debt from the new mortgage, his debt ratio is about 70% if we exclude his estimated bonus income. Counting his bonus income he can carry both mortgages fairly easily with low debt ratios. Alternatively, not considering the carrying cost of his current home, his debt ratios are well within guidelines even if we ignore his annual bonus.
According to current mortgage pricing models and underwriting guidelines, Client A is the least risky loan. In fact, Client A would have a conforming mortgage of about 6.5% on a 30 year fixed today. This would be an easy deal because I also get an automated approval from Fannie Mae’s Desktop Underwriter and Freddie Mac’s Loan Prospector.
On the other hand, Client B came to me after their loan was denied by another bank. The problem is two fold. First, underwriting guidelines for traditional mortgages focus more on income than wealth. So even though Client B is clearly a common sense loan, most banks would deny the loan because they can’t document enough monthly income to cover the mortgage and existing debts OR because they want to count the current home’s mortgage payment in the debt ratios because it has not yet sold (home is listed for sale). Fortunately, I am able to get this deal done as a full documentation loan, but it took several wholesale investors saying no to exceptions before I finally found one. Many that said no, would beg me all day long for Client A’s loan.
I know, you are again thinking WTF?
Client B is a victim of over efficiency in the mortgage business. Back in the day before computers, FICOs, CDOs, hedge funds, automated underwriting systems, and call centers, people used to put on a suit and go meet their banker and apply for a mortgage loan. The banker would look at their loan and maybe took it to a credit committee who made a lending decision based on credit, capacity, collateral, and character. In other words, you were more than just a number but a customer of the bank and they tried to assist you financially by making a sound lending decision.
Skipping to 2007, none of that matters anymore. All that matters is can your loan be sold to Wall Street. The system is set up so that FICO scores are king and all loans must fit into a rigid box so they can be packaged and sold. Unfortunately, because of the volume of loans and so many investors are buying pools of mortgages, it leaves no room for common sense underwriting. Underwriting mortgages isn’t about making good loans anymore. It is about making sure loans can be sold which leaves us with situations above where a documentable millionaire can’t get a mortgage, but a guy living check to check with a three year old bankruptcy qualifies for the lowest rates in the market.
I believe respected mortgage blogger, Brian Brady called this the mortgage tax. The good is paying for the bad. I call it stupid underwriting. It isn’t about needing a stated income loan or needing some other non-traditional mortgage product. It is about someone actually being required to think and make a common sense lending decision based on the facts at hand, not whether we can fit into a product matrix and the risk models.
Mortgage banks and lenders need to go back to actually sitting down with each client individually and making rational and logical lending decisions.
Well Russ,
Sadly this is so true, the mortgage business is about “do you fit this or do you fit that?” not “does this actually make sense?” Because if client A came to me and said “Rick, would you let me borrow $100k” I would probably laugh at him and if client B said the same thing I’d happily sign over $100k to him because it just makes sense. Its obvious that he is able to repay that money. Sadly the computers can’t see that…Good blog as always Russ
Russ,
Well stated article. I believe that the system has far more common sense then you would imagine. The problem is the underwriter at the other end who is going to “verify” that submission. Many of them have been in the business less than 6 years and have no idea how to underwrite a loan, and they are also scared to death, right now, of buy backs.
Therefore, they are going to error on the side of extreme conservatism. When I was reading your story, I was saying to myself that client B is approvable all day long.
I always made sure that I had a common sense head underwriter at my disposal for just these types of loans.
If your client has had this million bucks for a period of time you could amortize the money at 5% and add to his income. Also, whoever told you that you needed to count the other house payment was nutso. That is a contingent liability and with a million bucks in the back they shouldn’t have to worry. Just those two items right there gets your loan approved.
I am glad you found someone whose head wasn’t in the dark place in your photograph!
Thanks for the comments.
Dave, I agree. U/W’s who said no are nuts! Surprisingly, I did go through quite a few A paper guidelines and it wouldn’t fit. Most wanted him to put 20% down instead of allowing the CLTV to 90% as desired to exclude the current housing payment. Fortunately, I have more lenders at my disposal than I can count, so I found a few that would do it. It also required doing a little manipulation of the loan amounts. Instead of having the first as a Jumbo, I maxed it at $417k and put the rest on the second. This actually got him a much better deal than keeping it as a Jumbo.
We agree about u/w being cautious. Many lenders have replaced seasoned underwriters with processing clerks, so again, no one thinks anymore and is afraid to make exceptions.
One day “MAYBE” Wall Street will find the middle ground; until then think GSE!
I will use many of your points to educate my consumers; thanks!
That pic is great! Thanks for a great read!
Brilliant analysis! “Over-efficiency” in the mortgage business…I love it!
Brian
It is also known as analysis paralysis. I honestly believe the lenders have been sold a bill of goods in regards to their risk models. Don’t let me get started on FICO scoring…
It just frustrates me that no one wants to make decisions. Everything has to fit into a box. If one little thing isn’t in the box, no matter how illogical, underwriters freeze up. We all know DU and LP sometimes makes mistakes. Good luck finding a lender that will actually do a manual underwrite nowadays.
Having worked for years on the secondary marketing side for a major subprime shop, I have to say that in the old days (meaning last year and beyond), if you weren’t doing agency paper and your lender sold in the private sector, you could get out of the box exceptions pretty easily depending on how strong you were in your Secondary Marketing area. I had the pleasure of working for nearly a decade with a woman who is arguably one of the most knowledgeable and prolific Chief Credit Officers at any wholesale lender you could name. She developed a Secondary Marketing Due Diligence response team of auditors that would push-back when investors would send in their auditors to review a bulk loan sale population in order to remove or reprice transactions they had already bid on at a certain price. Under the auspices of ensuring they get what was represented in the data tape they initially bid on, investors ultimately cherry pick the product and reprice so that they end up getting only the stuff the really want and getting it for cheaper than the bid amount that allowed them to secure the sale. What my boss did was to have our own team of auditors in place to respond to each deficiency finding by either fixing it or rebutting it with compensating factors, forcing the investor’s auditors to overturn their material deficiency conclusion. What they refused to overturn, she would then review each loan personally to determine if she had ANY sort of common sense backing for the loan having been made, irrespective of how many exceptions to guidelines had been made. She would then take those loans and force the investor’s chief trading officer to sit with her on the phone for hours while she went through each one, systematically making a case for each loan and demanding somethng other than “we just don’t like this one” before she would concede to let a loan she liked be removed from the sale. As a result, over 8 years she maintained above a 90% execution rate in terms of the investor buying what was bid on and doing so at the bid price, which was previousl unprecedented. All that to say that what it allowed the production side to do was to make those “make sense” deals and sign multiple exceptions, knowing that the loan was not going to be forced to be sold at less than a premium price (what we call “scratch and dent”). If an ecxception was really outside the box, the sales managers would even take the loan to my boss asking if it could be done. She would either make the call herself on the basis of knowing she could fight to get it sold at a premium, or she might even run the deal by the trader at one or two of our buyers and ask if they would do it.
Granted, this was subprime and there was the room to do that, but I can tell you that we saw a lot of superior paper come our way because brokers were finding that we would do those “make sense” deals that were out of the box.
Of course, now, its a whole different ball game, and originators really are at the mercy of “the box”, which seems to be shrinking day to day.