Chapter 2

Reducing Frustration, Delays and Costs

Edward and Margaret Hartman did not remember their previous mortgage experience fondly. “We were pressed for time,” recollected Mr. Hartman about the move from Ft. Lauderdale to Sarasota, Florida. “We had provided the lender with all the information needed two weeks earlier, but we did not get a commitment until two days before closing. We closed on the Sarasota home the same day that the moving truck was pulling in.”

When the couple, both 32, later transferred from Florida to the Atlanta area, they chose to work with a lender offering a 48-hour loan decision guarantee. True to its word, the lender responded within two days—with the help of automated underwriting. The Hartmans got their loan.

“It was extremely painless,” Mr. Hartman said, “and we were extremely pleased.”

Automated underwriting is good news for the Hartmans and other homebuyers eagerly waiting for loan approval. Many families enter the mortgage market with high hopes and expectations, which later fade when days stretch into weeks as their applications undergo processing and review. In some cases, confusion and frustration prevent families, especially those with limited experience in the mortgage market, from purchasing homes. (See Frustration Sidelines Some Renters, )

The challenge of navigating the mortgage-approval process intensifies when the demand for mortgages is high. Ironically, when mortgage rates fall and homeownership becomes most affordable, lenders are busiest and can least afford to give extra time to families in need of more attention. Traditional loan processing puts every loan application—whether a clear-cut approval or a tough call—through the same paces. Automated underwriting can eliminate these bottlenecks without shortchanging the integrity of the decision-making process.

By returning an accurate loan evaluation within four minutes, Loan Prospector slashes the time between loan application and closing from weeks to days, greatly reducing borrower uncertainty and costs. The reduction in closing costs made possible by automated underwriting will help move tens of thousands of renters into homes of their own.

Using Loan Prospector

Consumers already are well acquainted with the blink-of-an-eye responses that technology makes possible. Most people do not think twice about swiping their credit cards through a machine on the gas pump or letting a supermarket check-out scanner tabulate their grocery bills. In a few years, homebuyers will feel the same way about automated underwriting: They will not be able to imagine buying a home any other way.To use Loan Prospector, a lender enters a borrower’s application information into its own computer system, as illustrated in Exhibit 1.

The information then is communicated electronically to Loan Prospector, which, in turn, collects credit information from other sources. Loan Prospector weighs all of this information to determine the likelihood that the loan will be repaid, based on the way similar mortgages with comparable borrower, property and loan characteristics have performed in the past.

On the basis of this comprehensive evaluation, the loan application is assigned to one of three risk categories:

• Accept. An accept designation indicates the lowest level of risk. The majority of applications reviewed by Freddie Mac through automated underwriting fall into this category. Assuming the information provided is accurate, Freddie Mac stands ready to purchase these loans.
  
• Refer. A refer designation signifies that the application needs further review. Loan Prospector provides feedback to help the lender focus on those aspects of the application requiring attention. Based on additional review, underwriters have determined that many of these loans, when supplemented by more information, are acceptable for sale to Freddie Mac.
  
• Caution. A small fraction of applications receives a caution designation, meaning that the application carries substantial risk and warrants significant reexamination by the lender. In these cases, Loan Prospector identifies which aspects of the application prompted the caution warning. If extenuating circumstances make the loan a better risk than the available statistical information indicates, a lender still may originate and sell a caution loan to Freddie Mac.

Collateral ExpressSM and Other Features of Loan Prospector

In addition to the risk classification, Loan Prospector provides an optional collateral assessment service, Collateral Express, which helps lenders determine whether the property is adequate to serve as security for the loan. In many cases, an automated collateral assessment can replace the traditional property appraisal and can be completed much more quickly. Collateral Express typically delivers an assessment within three days.

Along with the collateral assessment, a lender receives census tract information and other data needed to comply with Home Mortgage Disclosure Act (HMDA) reporting requirements. The assessment determines whether the home is located within a federally designated flood zone, meaning the property must carry flood insurance. If so, the service automatically provides the paperwork needed to comply with federal flood insurance guidelines.

Loan Prospector also permits lenders to request mortgage insurance electronically from a number of participating insurers.1

Automated Underwriting Reduces Mortgage Origination Costs

The increased efficiencies resulting from automated underwriting combine to reduce mortgage processing costs in several ways:

Processing and underwriting. Loan Prospector reduces the amount of time it takes to process mortgage documents from days to minutes. In many instances, time-consuming verifications of income and employment as well as borrower letters to explain employment gaps and derogatory credit incidents are no longer needed. The happy result is far fewer phone calls, letters, overnight deliveries and faxes. These processing efficiencies reduce costs and allow applications to move more swiftly to approval.

Appraisals. The automated collateral assessment feature pioneered by Freddie Mac also can produce significant savings. Borrowers enjoy lower out-of-pocket fees, while a speedier property valuation expedites mortgage approval.

Lender Warranties. Loans tagged by Loan Prospector as accept are easier and less costly to sell to Freddie Mac. Given the company’s confidence in Loan Prospector, fewer loan documents are required. Freddie Mac also relieves lenders from providing certain legal representations about the quality of the loans, eliminating potential future costs. Because Loan Prospector classifies most loans as accept, the savings quickly accumulate.

Lenders have reported to Freddie Mac that using Loan Prospector already is saving them $300 to $650 per loan. As the service expands and improves, we fully expect these savings to grow. Industry-wide competitive pressures will compel lenders to pass cost savings on to borrowers.

Cost Savings Will Enable More Families to Buy Homes

The cost savings resulting from automated underwriting will help reduce a particularly onerous barrier to homeownership: high closing costs. Paid at settlement, these out-of-pocket fees can prove prohibitive.

President Clinton highlighted this concern:
A modest starter home today costs about $94,000 in many parts of the country . . . With only 5 percent down [$4,700] and closing costs [$4,300], that’s about $9,000 up front. Half the young families in this country make about $25,000 a year. Well, it’s hard to save $9,000 . . . . Many families are paying more in rent than it would cost them to own a home and to build equity, but they can’t come up with the front-end money. We have to do better. 2

Responses to a 1996 survey likewise reflect this concern. Fifty-two percent of those interviewed cited the lack of money for a down payment and closing costs as a “major obstacle” to homeownership.3

Closing costs hit low-income families particularly hard. Most of the documentation, appraisal and other third-party services necessary to close a loan cost the same for every homebuyer, regardless of the price of the home. Consequently, closing costs represent a greater portion of the total cost of purchasing a home for low-income families.

The potential savings from automated underwriting will be large enough to overcome the down-payment and closing-cost hurdles for tens of thousands of families. A $400 reduction in closing costs for every borrower, for example, would increase the number of families qualifying to buy a home by roughly 70,000 households, according to Freddie Mac estimates based on Census Bureau research.4 More than one-half of these households would be low income, with incomes 80 percent or less than their area medians. Larger cost savings would increase the pool of potential homebuyers even more.

African-American and Hispanic families would experience the largest relative gains. A $400 reduction in closing costs, as shown in Exhibit 2, would increase the number of minority renters who have adequate funds to buy a home by 8 percent.

Adding up the potential impact, a $400 reduction in closing costs on every mortgage made in 1995 would have saved borrowers $2 billion.5

Far from supplanting the important borrower/lender relationship, automated underwriting will serve as a lender tool to ease borrower anxiety, expedite processing and reduce costs. As a result, it will lower barriers that prevent many minority and low-income families from owning their homes.

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