So how much did technology and more specifically, automated underwriting, factor into the current subprime crisis? In this former lender’s opinion, the impact was substantial.
The widespread use of automated underwriting (AU) technology eventually brought subprime lending into the 21st century. Although systems were slow to develop, most lenders had some form of AU technology in place by 2004. The more robust systems used risk-based decision-making that went beyond basic underwriting guidelines. If a borrower’s compensating factors warranted a loan exception, the best systems could make that call.
These AU systems also helped remove the guesswork. With AU approval, a broker had something more tangible to tell his borrower and his Realtor. Since lenders stood behind their systems, an approval all but guaranteed a loan would fund. As long as the property value could be substantiated and the information on the application could be verified, there was a good chance the loan would close.
AU systems not only modernized the subprime industry, they helped address the greatest frustration for lenders and brokers –– scores that declined from lenders reordering credit reports. When I opened my company back in 2000, before AU technology became the norm, most brokered loans underwent a similar process. The broker started by sending a loan application and credit report to his wholesale account executive for prequalification.
For example, let’s assume the borrower had a 590 credit score and was pre-approved for 100 percent financing. When the loan arrived at the lender’s office three weeks later, the lender ordered a new credit report; standard operating procedure. In this case, the score dropped to 550. Since the lender used their scores to underwrite the loan, the borrower was no longer eligible for 100 percent financing. With no cash available for a down payment, the deal quickly fell apart.
AU technology was instrumental in solving this problem. When a broker used a lender’s AU system to approve a loan, he could utilize his credit report to run the deal. Once the loan file arrived at the lender’s office, the underwriter would access the system and print out the broker’s credit report in the lender’s name. The issue of falling credit scores became a thing of the past.
The issue of course, is that the system was being gamed. When a credit score drops, it means one of three things:
- The borrower was recently late on a payment
- He is using more of his total available credit (maxing out credit cards)
- He has applied for new credit
When any or all of these happen, the borrower becomes a greater credit risk, which causes his score to deteriorate.
Most investors considered credit reports to be valid for 60 days. This meant a loan had two months to close from the date the credit report was issued, otherwise a new report had to be ordered. Some investors were more aggressive: credit reports issued through Assetwise, GMAC Residential Funding's AU system, were valid for 120 days. Although it provided lenders with a great selling tool to brokers, this may have been the single worst risk policy implemented in the history of RFC. The 60-day time limit has a purpose: high-risk borrowers are less responsible than prime borrowers when it comes to managing their credit.
Allowing them 120 days between the time credit is ordered and a loan is closed is long enough to have every account go to collection, file for bankruptcy, get divorced, and have time to spare.
This credit policy created a Catch-22. When a broker’s credit report being used through Assetwise was over 60 days old, many lenders who sold to RFC pulled credit again to be certain nothing drastic had happened with the borrower. When the credit score dropped significantly, it left them with two choices: decline the loan and upset the broker by not standing behind the AU system, or close a mortgage for a borrower who no longer qualified.
The challenge was that if a lender didn’t stand behind the automation, it was no longer viewed as a worthwhile tool. Since lenders were falling over each other doing whatever was possible to get the broker’s business, choosing not to close the loan and essentially announce to the broker community you only stood behind your technology on occasion, created a challenge.
For all the benefits AU technology brought to subprime lending, one thing is clear––automation helped lenders close loans that should’ve been declined. Eight years ago, the issue of falling credit scores was a common occurrence in subprime lending. Until automation became a standard part of the business, 10-15 percent of loans that brokers submitted to my underwriting department were turned down for this reason.
Getting an AU approval for loans that should’ve been denied didn’t make the borrowers credit-worthy –- it meant technology had found a way to circumvent the issue.
Note: Richard Bitner is the author of Greed, Fraud and Ignorance: A Subprime Insider's Look at the Mortgage Collapse, and has appeared on CNBC and in Newsweek, among other media outlets. As a 14-year veteran of the mortgage industry, he spent five years as the President of Kellner Mortgage Investments, a subprime mortgage company. In addition, he was a Director for GMAC Residential Funding and the National Training Manager for GE Capital Mortgage Insurance (Genworth Financial).