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Chapter
5
Expanding
Markets
After
landing
a full-time,
$26,000-a-year
job,
Ray
Evans
of Normal,
Illinois,
was
ready
to move
out
of his
parents’
home.
Over
three
years,
he had
accumulated
enough
money
for
a down
payment—with
a little
help
from
his
mother
and
father.
The
first
lender
Mr.
Evans
approached
turned
him
down
for
a
conventional
mortgage
to
finance
a
modest
$80,000
ranch
house.
His
down
payment,
the
lender
said,
was
insufficient
to
consider
him
for
anything
but
a
government-insured
mortgage.
Then
Mr.
Evans
found
a
small
local
lender
that
uses
automated
underwriting.
Within
three
weeks
of
loan
application,
the
27
year
old
was
pocketing
the
keys
to
his
first
home.
Able
to
weigh
Mr.
Evans’
proven
ability
to
manage
his
credit
obligations,
including
a
car
loan
and
credit
card,
against
other
factors,
Loan
Prospector
classified
his
application
as
an
acceptable
risk.
“The
loan
officer
told
me
my
application
was
going
off
to
an
automated
loan
system,
but
I
felt
very
comfortable
with
that,”
Mr.
Evans
recalled.
Automated
underwriting
is
opening
the
doors
of
homeownership
to
new
groups
of
borrowers.
By
increasing
the
accuracy
with
which
mortgage
applications
are
underwritten,
systems
such
as
Freddie
Mac’s
Loan
Prospector
enable
lenders
to
approve
more
first-time
homebuyers
like
Mr.
Evans.
In
addition,
Loan
Prospector
can
lower
interest
rates
for
thousands
of
borrowers
with
high-cost
mortgages
by
bringing
them
into
the
conventional
market.
Approving
More
Borrowers
Throughout
this
report,
we
present
real-life
examples
of
borrowers
who
have
been
helped
by
Loan
Prospector.
In
the
past,
such
borrowers
might
have
been
denied
credit
or
been
directed
to
a
more
expensive
type
of
financing.
Now,
with
the
help
of
Loan
Prospector,
lenders
have
the
confidence
they
need
to
offer
low-cost
conventional
mortgage
financing
to
borrowers
who
may
not
fit
the
traditional
profile.
Estimating
the
number
of
potential
borrowers
who
could
be
helped
by
the
increased
precision
of
Loan
Prospector
is
admittedly
difficult.
However,
based
on
preliminary
evidence,
Freddie
Mac
believes
the
impact
will
be
significant.
With
its
sharper
tools
to
identify
creditworthy
borrowers
who
may
have
been
overlooked
by
traditional
underwriting,
Loan
Prospector
can
increase
the
number
of
homeowners
by
as
many
as
250,000
families.
1
Lower
Aggregate
Risk
Boosts
Lending
Automated
underwriting
also
will
identify
as
high-risk
some
applicants
who
might
have
been
approved
under
traditional
underwriting.
A
high-risk
classification
does
not
always
result
in
a
loan
denial,
however.
2
Some
applicants
have
extenuating
circumstances
that
make
them
acceptable
credit
risks.
Nevertheless,
as
automated
underwriting
becomes
more
widespread,
the
number
of
high-risk
applicants
who
receive
loans
will
decline.
Reducing
the
number
of
high-risk
borrowers
initially
will
lower
the
average
risk
that
the
mortgage
industry
must
absorb.
As
average
risk
declines,
however,
competitive
pressures
will
spur
the
market
to
expand
at
the
margin,
bringing
in
borrowers
whose
current
profiles
put
them
just
beyond
existing
standards.
The
net
effect
on
the
size
of
the
market
inevitably
will
be
positive.
Substituting
borrowers
just
at
the
margin
for
borrowers
with
significantly
higher
rates
of
default
will
enable
the
industry
to
serve
a
greater
number
of
families
without
increasing
overall
risk.
This
increase
will
be
in
addition
to
the
250,000
borrowers
overlooked
by
traditional
underwriting
but
found
to
qualify
thanks
to
automated
underwriting’s
greater
precision.
Lowering
Interest
Rates
Across
Markets
Not
only
will
automated
underwriting
expand
mortgage
credit
to
a
new
generation
of
homeowners,
it
also
will
allow
many
existing
borrowers
to
take
advantage
of
lower
mortgage
rates.
Early
evidence
from
a
pilot
program
shows
that
automated
underwriting
will
classify
many
borrowers
now
relegated
to
the
higher-cost
subprime
market
as
acceptable
risks
by
conventional
market
standards.
The
shift
of
these
borrowers
into
the
lower-cost
conventional
market
will
benefit
minority
and
low-income
families
the
most.
Improving
the
Subprime
Market.
The
subprime
mortgage
market
accounts
for
about
5
percent
of
total
mortgage
originations.
Typically,
borrowers
turn
to
this
market
when
credit
problems
or
other
circumstances
make
them
ineligible
for
conventional
or
FHA
financing.
Borrowers
with
subprime
mortgages
usually
pay
significantly
higher
interest
rates
than
other
borrowers.
To
address
lender
demand
for
an
automated
underwriting
service
capable
of
evaluating
loans
in
any
mortgage
market,
Freddie
Mac
joined
forces
with
S&P,
a
rating
agency
with
significant
experience
evaluating
subprime
loans.
Based
on
its
independent
assessment,
S&P
concluded
that
Loan
Prospector
“evidences
a
high
degree
of
predictiveness
coupled
with
consistency
of
scoring”
for
subprime
(and
jumbo)
loans.
3
Buoyed
by
these
results,
we
initiated
a
pilot
program
in
October
1995
to
make
automated
underwriting
available
to
the
subprime
mortgage
market.
Although
the
mortgages
originated
under
the
pilot
will
not
be
sold
to
Freddie
Mac,
other
investors
stand
ready
to
purchase
these
loans.
Bringing
automated
underwriting
to
the
subprime
market
promises
its
borrowers
increased
efficiencies
and
lower
processing
costs.
Interest
rates
on
subprime
mortgages
also
should
fall
as
investors
become
more
confident
that
the
default
risk
on
these
mortgages
has
been
reliably
analyzed.
4
Identifying
More
Conventional
Borrowers.
In
the
course
of
the
pilot
program,
Freddie
Mac
made
a
significant
discovery.
Not
only
did
Loan
Prospector
improve
the
processing
of
subprime
mortgages,
it
also
identified
applicants
in
the
subprime
market
who
would
have
qualified
for
lower-cost
conventional
financing.
Preliminary
Freddie
Mac
estimates
suggest
that
between
10
and
35
percent
of
borrowers
who
obtained
mortgages
in
the
subprime
market
could
have
qualified
for
a
conventional
loan.
5
A
recent
poll
of
the
50
most
active
subprime
lenders
supports
this
conclusion.
The
survey
found
that
up
to
50
percent
of
subprime
mortgages
could
qualify
as
investment-grade
mortgages,
although
some
of
these
loans
would
fail
to
meet
certain
secondary
market
criteria.
6
Breaking
out
of
the
subprime
market
promises
to
confer
significant
benefits
to
families
who
believed
they
had
no
other
choice.
Minority
and
low-income
borrowers
are
most
likely
to
be
affected.
African-American
and
Hispanic
borrowers
are
represented
in
the
subprime
market
at
nearly
triple
their
rates
in
the
conventional
market,
while
low-income
borrowers
are
represented
at
about
one-and-one-half
times
their
rates.
7
Subprime
borrowers
who
would
have
qualified
for
conventional
loans
pay
mortgage
rates
on
the
order
of
one
to
two-and-one-half
percentage
points
higher
in
the
subprime
market,
based
on
Freddie
Mac
estimates.
8
A
one-and-one-half
percentage
point
savings,
for
example,
would
mean
paying
8.5
percent
instead
of
10.0
percent
for
a
mortgage.
Moving
to
the
conventional
market
means
that
qualifying
subprime
borrowers
could
save
roughly
$50
to
$130
a
month
on
a
$75,000
30-year,
fixed-rate
mortgage—significant
amounts
for
hardworking
families.
In
the
aggregate,
these
families
could
save
up
to
$100
million
in
interest
costs
each
year
by
obtaining
conventional
loan
financing.
Footnotes:
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