Where Due-Diligence Underwriters Go Wrong
Brokers should know the six main areas mistakes occur and how to handle repurchase demands
By David L. Hippensteel, council member, Gerson Lehrman Group Councils
roles have changed in the past
three years. They were once employed primarily by large investment banks
and firms looking to purchase residential
mortgages on the secondary market. Loan-default and foreclosure increases, however,
have caused private-mortgage-insurance
companies to hire these firms. Additionally, holders of recently defaulted loans
now rely on due-diligence underwriters to
support repurchase actions against mortgage originators.
At the same time, many due-diligence
underwriters now work for mortgage brokers. Who better to help brokers defend
against repurchase demands and potential
denials of mortgage-insurance claims than
the people who work for the other side?
The increase in demand has caused the
advent of many new due-diligence-underwriting firms. It has not, however, put an
end to all mistakes. Due-diligence underwriters — new and old — continue to make
serious errors when re-underwriting closed
mortgages. These blunders often result in
poorly supported repurchase demands and
Brokers who learn to spot due-diligence
underwriters’ missteps can better fight for
their and their clients’ rights. They also
can better oversee any due-diligence underwriters they might choose to employ.
Here are six common areas where due-diligence underwriters go wrong.
1. Overtime and bonus calculations
Standard underwriting requirements for
using overtime or bonus income in debt-to-income (DTI) calculations call for proof
that the additional income has been received for the past two years and that it
likely will continue in the future. Underwriters often take the latter half of this
requirement for granted.
Often, overtime and bonus income is
annualized improperly. One way this can
happen is when only the borrowers’ overtime or bonus income — and not their entire
income — is averaged over two years. This
mistake results in dramatically lower gross
monthly income and higher DTI figures.
2. Automated underwriting
Too often, due-diligence underwriters recommend repurchases based on the claim
that the original automated-underwriting
findings were invalid because of errors in
input data. This, however, does not matter if the data improved the loan submission’s quality.
Fannie Mae and Freddie Mac have
specific guidelines for when their automated-underwriting reports must be
run again because of changed input data.
If changed data such as increased income
or assets, a lower DTI ratio, or a lower loan-to-value ratio (LTV) decrease a borrower’s
risk level, automated-underwriting systems
would still produce an approve or accept
If a file was approved at 85-percent LTV
and the true LTV is 80 percent, resubmission wouldn’t matter.
evaluation, the underwriter generally
picked the given index amount on the day
the loan was reviewed.
Oddly, many due-diligence underwriters
look at the note to see when the rate change
was set to occur, use that date to pick the index to calculate the qualifying rate and then
apply the rounding limit from the note.
The loan-approval process must include
a specific day to establish the index used
for calculating the qualifying rate.
AVMs use the date of request to pick potential comparables. This often results in
an AVM value based partially on comparables that were available only after the
original appraisal date. The results from
AVMs also can include foreclosure properties, which aren’t reliable comparables.
Regardless of what some people say,
AVM comparables should be held to
the same standards as original appraisal
David L. Hippensteel is
a member of the Gerson
Lehrman Group Councils and an adjunct faculty member of Bryant
and Stratton College’s
department. He provides
3. Incorrect dates
It is important to pay attention to dates, particularly when dealing with once-popular
pay-option ARMs. These loans’ low introductory rates resulted in negative amortization for a few years before the loan reset to a
fully indexed rate. They often used an index
that changed daily, and underwriting guidelines required the borrower to be qualified
at the fully indexed rate.
While the margin for the qualifying
rate would remain the same as set forth
in the note, the timing of when to pick
the index was critical. In the past five
years, indexes for ARMs changed rapidly
in the course of any given month. When
these ARMs went to an underwriter for
4. Shopping salary databases
The debate surrounding stated-income
loans and reasonable stated incomes for
specific jobs continues. It’s easy to pick a
common job title and search different online salary databases for information about
how much a person employed in the chosen
profession makes. The problem is determining which database is the most accurate.
For a given batch of loans, due-diligence
underwriters should pick one online database and stick to it. Surfing from one database to another to find the lowest income
so that a loan can be failed for “
unreasonable stated income” is unacceptable.
onsite training in due-diligence underwriting,
due-diligence supervision, mortgage-fraud investigations, and mortgage repurchase-prevention
strategies to secondary-market mortgage-invest-ment banks, mortgage brokers, mortgage lenders
and commercial underwriting firms. He consults
public and private clients in consumer-credit
repair, debt management and residential foreclosure prevention. Reach him at refimortgages@
wi.rr.com or (414) 801-7368.
5. Questioning original appraisals
The use of automated valuation models
(AVMs) to question appraisal values has
grown dramatically in the past year. AVMs
serve a valuable purpose, but the data behind them warrants careful review. Using
post-closing AVMs to question original
appraised values is common among due-diligence underwriters.
The critical error with AVMs involves
the dates of the comparables used. Many
6. Not reading front-end guides
Many new due-diligence-underwriting
firms believe that all front-end underwriting guides follow standard Fannie
Mae and Freddie Mac guidelines. Not so.
Wholesale lenders were free to make their
own guidelines. Those loans’ purchasers
should have read the guides before agreeing to purchase them.
Some wholesale lenders allowed borrowers to use cash-out proceeds as reserves.
Also, not all lenders required seasoning for
assets. Too many new due-diligence-underwriting firms are so eager to make their
clients happy that they don’t realize or investigate what the front-end underwriting
guides really were.
■ ■ ■
Because of the opportunity for errors in
due-diligence underwriting conducted by
those looking to pin the blame on brokers,
more brokers now realize the value of having their own due-diligence underwriters.
It might sound like a complicated circle,
but it’s one that can keep brokers from losing money and face.
Illustration: Dennis Wunsch