Monday, April 21, 2008

FNMA Underwriting Sham 2: Subprime FHA Loans

I keep hearing how the mortgage industry has reformed itself and how underwriting guidelines have been tightened- especially at Fannie Mae.

So, you can imagine my surprise when I received an Approve/Eligible on a loan with a 52% debt to income ratio in a declining market with 3% down, 2 months reserves, and a 241% increase to housing expense. This type of lax approval is reminiscent of subprime loans and helps explain the rising FHA delinquency rate which is now 16.73 nationally.

Note: the following is an actual FNMA AUS approval on a FHA loan:

Of course an AUS/TOTAL Scorecard approval doesn't mean that the lender will fund the loan, but it does mean that a Direct Endorsement Underwriter does not have to certify that they personally reviewed the credit application (including the analysis performed on any worksheets). As you can imagine, FNMA AUS and TOTAL Scorecard approval makes it infinitely easier for a broker or lender to fund an otherwise high risk loan with relaxed documentation standards.

Needless to say, since this is a prime example of the quality of FNMA AUS/FHA TOTAL Scorecard decisioning on FHA loans, continued trouble with delinquencies and defaults are likely on the horizon for FHA. Regardless of any other factor, this underwriting recommendation demonstrates that FNMA AUS/TOTAL Scorecard decisions are lax and produce approvals on high-risk, non-investment quality loans.

Considering that this is a jumbo FHA loan in the epicenter of the housing bubble, you'd think that a DTI this high combined with a substantial increase to housing would at least require a manual credit review. But, in a high cost of living area where the median price home is 7-8 times the median family income, debt ratios have to be stretched to offset the loss of stated income products if housing prices are to be held up to bubble levels.

While some may justify the decision by saying, "Yeah, but the borrower has high residual income". Really? a single man in that tax bracket? With income that is too high to write off mortgage insurance and whose debt exceeds 60% of assets? Some may also say, "What about the borrower's high credit score?" While the borrower clearly has a high credit score, this reflects the borrower's willingness to pay his credit obligations and manage his current expenses. However, the borrower's credit score in and of itself does not verify capacity or necessarily justify layering of multiple underwriting risks which include high DTI, declining market, large increase to housing, minimum 3% down payment, and minimal reserves. Again, this is a Federally Insured loan we are talking about here.

Please note that this is only an example and in all fairness, I must let you know that I was only testing the system. The reality is that the borrower actually had 6 figures in reserves which I excluded and a large obligation with less than 10 months remaining that I included. Plus, I bumped the rate for good measure. Needless to say, DU/TOTAL Scorecard loved it anyway.

While it may be easy for some to dismiss, the state of AUS clearly shows that greater change is required in the industry, and that FHA is the new subprime courtesy of the taxpayers.

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