Summary
Fannie Mae announced on December 5, 2007 that down payment requirements will be increased by 5 percentage points over the previously allowed minimum down payment in areas identified as declining. While Fannie’s Desktop Underwriter (DU) will generate a message on loan casefiles when it appears that the property is in an area of declining home prices, Fannie also “strongly encourages” lenders to use other tools to independently assess current housing trends. Kenneth Harney’s article notes that Countrywide has provided mortgage brokers with county wide ratings while GMAC-ResCap has provided brokers with zip code based ratings. The higher level approach to declining markets resulting in an additional 5% investment by the homebuyer could lock some buyers out of the market and also will likely result in lenders having to defend themselves against new claims of redlining.
Analysis
Mortgage loan underwriting has always been an exercise in playing the odds based on prior outcomes. These past outcomes supposedly foretold the risk a lender was taking with each individual loan level underwriting decision. Widespread reductions in home values added a new variable that was not part of the industries previous experience. Although the appraisal form always afforded the appraiser the opportunity of noting that the property was in a declining market, expecting the appraiser to unfailingly do so ignores the significance of taking an action that results in their facing the wraith of the seller, buyer, realtor, and regrettably the loan originator as well. Increasing home ownership has been a longstanding Washington policy objective regardless of administration and while there will be no announcement changing this objective it is clear that Washington now intends to place more blame on the lender when that homeownership opportunity ends in foreclosure. Much of the current problem shaking the financial industry results from the smaller subset of loans identified as subprime, but the restrictions noted herein cover the larger prime market. Does the industry need to use additional data sources instead of relying on the appraiser? Yes, the current crisis and the public and political perceptions are too strong to be solved by lenders promising to make better use of an overlooked checkbox on the appraisal form. The structure of the mortgage industry has changed over the years and with the majority of loans now originated by brokers we have a system in which the entity originating the loan enjoys the greatest financial benefit if the loan closes and suffers the least risk if the loan is not repaid. This is not intended to blame the problem on brokers but rather to stress that lenders must insert themselves in the process and that can only be done in conjunction with supplemental data sources as suggested by Fannie Mae. Are the critics correct in stating that county and zip code tools are too high level for the task? They likely are but it is a starting point that can initially be complimented by exceptions made on an individual case by case basis. It does change the dynamics for the appraiser as they will have to refute the higher level declining designation with specific facts if they believe the subject property should not be designated as declining. In this market that is a reasonable shift in the burden of proof. Taking this a step further, is it redlining? That is certainly not the intent but that offers little protection to lenders. The DU solution for valuation has some of the same benefits as it has for credit underwriting, the mystery of the black box answer that can be defended as the result of methodical calculations while noting a county or zip code as declining might be accurate it appears a bit more capricious. The same politician that blames the lender for over lending to his constituent will not accept as a solution that designates his entire district as a declining market. The high level declining market designations gets the lender in the game and when combined with an effective exception program is a reasonable starting point. Lenders and mortgage data providers need to work together quickly to harness the vast amount of existing data, much of it used in Automated Valuation Models (AVM) to combine the field appraisal and data valuations into one to enable a narrowing of the declining market geography. Looks like a good opportunity for the data providers.
