Automated Underwriting Is Holding Us Back

Five million. That’s the number of worthy individuals who were denied a mortgage between 2009 and 2014, yet would have received one in 2001, according to the Urban Institute.

Indeed, underwriting standards are much, much tighter than they were compared to 2001, well before the mortgage crisis took place. Laurie Goodman, the director of the Urban Institute’s Housing Finance Policy Center, said lenders have “plenty of room to safely ease credit,” adding that their unwillingness to do so is deterring a recovery in mortgages and the broader economy.

While I can’t verify the Urban Institute’s methodology and conclusions, I would agree that many lenders are being too conservative for their own good – and the good of the nation as a whole – now more than five years after the worst of the crisis.

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There are several reasons why many lenders are now reluctant to lend to people they gladly would have accepted as borrowers before. Some are valid, but some are not.

What I have found is that many lenders are taking the easy way out, preferring to turn away business rather than doing a little extra due diligence to help more prospective borrowers.

Since the advent of automated loan underwriting systems, many companies have been lulled into a false sense of security by relying on these engines. They have lost the art of truly understanding credit risk. And that means not just making sure you don’t make loans to those who are deemed to be poor credit risks; it also means making an extra effort to make loans to people who are good risks but may not appear to be at first blush.

Underwriting systems certainly have a role to play and are responsible for some of the recent improvement in mortgage credit quality. But by relying too heavily – in some cases, exclusively – on automated underwriting, many lenders have denied loans to creditworthy borrowers in the name of tighter underwriting standards. In the process, they’ve not only reduced their own new business, but failed to help people who can really use it, which is, after all, why this business exists.

We see that first-hand in the market for Veterans Administration-guaranteed mortgage loans.

According to Ellie Mae’s December 2015 Origination Insight Report, the closing rate on VA refinance loans was less than 44% in December, which was by far the lowest of any loan type Ellie Mae tracks (and trending downward). By contrast, the closing rate on purchase VA loans was almost 74%, the highest of any loan type.

Yet, other things being equal, it should be the other way around. While the average FICO score on closed loans on both types was almost identical, the LTV on refis was quite a bit lower, implying that refis should be less risky, not more. Indeed, most VA purchase loans are made to active-duty military personnel, who unfortunately, tend to have lower FICO scores due to their young age and multiple deployments. Try maintaining a good credit rating when you’re in the field. By contrast, the typical VA refi customer, in our experience, is older, retired and has more home equity but also more debt.

Most lenders shy away from these loans because they don’t understand how to underwrite credit for potential risk. Many of them believe that lending to veterans is too risky because they’ve bought into negative stereotypes about this group, or their underwriting systems deny loans willy-nilly without digging deeper to find out whether or not these people are genuinely credit-worthy. Many lenders, sad to say, just don’t want to be bothered.

But according to recent studies by the U.S. Census Bureau and others, veterans are better educated, make more money, and have better benefits than non-veterans, yet many of them find themselves at the mercy of a computer software program.

Lenders can’t rely solely on these systems to make yes or no decisions – not unless they’re satisfied in denying credit to people who can really use it and use it responsibly. Plus, it’s the right thing to do.

And after all, isn’t that why we’re in this business?

About The Author

Joe Murin

Joe Murin is former President of the Government National Mortgage Association under both the Bush and Obama Administrations, and is a member of the Board of Advisors of NewDay USA, a leading VA lender.