Executive Summary

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Automated Underwriting: Making Mortgage Lending Simpler and Fairer for America's Families

For a quarter century, Freddie Mac has worked to create the best housing finance system in the world. Today, because of the efficiencies of the secondary mortgage market, families in communities across the country can rely on a steady supply of low-cost mortgage money.

Loan Prospector ®, Freddie Mac’s state-of-the-art automated underwriting service, is an important milestone in the company’s efforts to bring these benefits to even more families and neighborhoods. By reducing costs and by making lending decisions more accurate and consistent, automated underwriting promises to open doors for hundreds of thousands of new borrowers.

Benefiting Consumers

Automated underwriting delivers enormous benefits to consumers:

Lower Costs. Today, Loan Prospector is lowering costs by $300 to $650 per loan, and the savings can be expected to grow. As these savings are passed through to consumers, they will help reduce one of the greatest obstacles to owning a home: up-front costs.

Level Playing Field. Loan Prospector is blind to an applicant’s race and ethnicity, promoting fair and consistent mortgage lending decisions. Dispelling perceptions of unfair treatment and ensuring a level playing field will have a dramatic impact on the number of minority homeowners.

Expanding Markets. Loan Prospector improves the accuracy of lending decisions, making it easier to serve families who do not fit the traditional borrower profile. Families who were once turned down for mortgages or relegated to the more expensive subprime market will be able to qualify for conventional loans.

Over time, these three forces will combine to extend the reach of the mortgage market in unprecedented ways. Freddie Mac’s early experience with Loan Prospector provides a glimpse of this future.

The widespread adoption of automated underwriting will:

• Help put nearly three-quarters of a million of today’s renters into their first homes, 80 percent of whom will be low-income or minority families
  
• Save borrowers $2 billion in closing costs each year
  
• Move borrowers out of the subprime market and into conventional mortgages, saving them up to $100 million in annual interest payments

Looking Inside Loan Prospector

At the heart of Loan Prospector is a statistically based, objective measurement of risk. Although based on the same type of information that mortgage professionals have used for years, Loan Prospector uses actual performance of similar loans to weigh a multitude of factors with consistency and accuracy no human underwriter can match.

Loan Prospector evaluates a loan application and delivers a credit risk assessment to the lender in a matter of minutes. The majority of applications are classified as acceptable risks, making the loans eligible for immediate sale to Freddie Mac. In the remaining cases, applications are referred back to the lender for a closer review, along with guidance on areas for improvement. In many instances, such loans are later sold to Freddie Mac.

By expediting the underwriting process, Loan Prospector reduces the time between mortgage application and closing from weeks to days. For consumers, this eliminates much of the frustration and uncertainty involved in getting a mortgage. The objectivity of the system also assures consumers that their applications will be evaluated fairly.

This dramatic achievement did not occur overnight. Freddie Mac tested and retested Loan Prospector to confirm its predictive power and to validate its applicability to different groups of borrowers. The results speak loud and clear: Loan Prospector accurately forecasts loan performance, whether the borrower is African-American, Hispanic or White, and whether the borrower’s income is high or low.

Opening Doors to Homeownership

Sprinkled throughout this report are real-life examples of how automated underwriting helps families for whom traditional loan- approval methods are not working:

• Louise Beyler, a self-employed borrower whose debt ratios seemed too high to qualify her for a mortgage
  
• Edward and Margaret Hartman, whose previous loan did not close until the moving van was arriving
  
• Alejandro Hernandez, whose loan application was a study in complex layered risks
  
• Dawn Clark, whose difficult loan- origination experience led her to question whether she, as an African-American, had been treated fairly
  
• Ray Evans, who initially was told he did not qualify for a conventional loan because his down payment was too low
  

This report reveals how automated underwriting benefited these people, all of whom are homeowners today. By accurately assessing risk and accounting for compensating factors, automated underwriting provides lenders with the added confidence they need to serve borrowers who may not fit the standard profile.

Using New Knowledge

Automated underwriting is the wave of the future, but its widespread adoption will take time. Meanwhile, research conducted as part of the development of Loan Prospector is improving today’s manual underwriting process.

Freddie Mac’s research confirms that credit-bureau scores are simple yet powerful underwriting tools that summarize the complex information contained in an individual’s credit report. Because they are highly predictive of loan performance regardless of a borrower’s race or income these scores are extremely valuable in the hands of human underwriters and serve as an important bridge to automated underwriting.

Credit-bureau scores are primarily determined by consumers’ proven track records of repaying debts and their recent use of credit. The use of finance companies turns out to have only a small role in assessing risk and to vary little by race or income.

Keeping the Promise

As the industry sharpens its understanding of risk and puts technology to broader use, today’s automated underwriting systems will be refined and expanded. In a matter of years, homebuyers will not be able to imagine getting a mortgage any other way.

Already we are seeing signs of automated underwriting’s promise. For example, with the knowledge gained from developing Loan Prospector, Freddie Mac is able to offer traditionally high-risk products, such as loans with 3 percent down payments, with confidence that the borrowers will be successful homeowners.

Every day we are exploring new uses for Loan Prospector. Pilot programs will examine using automated underwriting to identify borrowers who would benefit most from homeownership counseling, for example.

Freddie Mac and the Department of Housing and Urban Development (HUD) are working together to evaluate how this technology can be used to expand homeownership opportunities by making loans insured by the Federal Housing Administration (FHA) more affordable and easier to originate.

In addition, working with Standard and Poor’s Corporation (S&P), Freddie Mac is making the cost savings and speed of automated underwriting available to borrowers in the subprime market.

Loan Prospector is a tool for the twenty-first century. By opening the door to a simpler, fairer and less expensive mortgage market, automated underwriting will help put more families into homes they can afford and keep.

The people of Freddie Mac are committed to delivering on the promise of automated underwriting. We are proud to play a pioneering role in making the world’s best housing finance system better still.