Dallas Fort Worth Area Homes and Real Estate

WHAT IS AUTOMATED UNDERWRITING?

Realtors and home buyers have likely heard lenders use the term automated underwriting, but many don't understand exactly what that means.   Automated underwriting is a computer program that uses an algorithm (a mathematical formula) to provide a loan recommendation (approval or denial).   It serves as a risk calculator tool for lenders. 

The recommendation is just that: a recommendation.  Lenders are under no obilgation to issue a loan approval just because automated underwriting determines a loan to be approved, but most will as long as they determine the overall loan parameters to be reasonable.  Many lenders have recently instituted arbitrary guidelines that supercede automated approvals, such as maximum debt-to-income ratios and requirements to pay off collections over a certain amount.  

A few years ago, most lenders would accept an automated underwriting approval regardless of whether the loan had excessive risk factors, but the recent surge in foreclosures has caused many lenders to re-think this policy.     

Automated underwriting considers many different factors in order to make a loan determination, such as: 

• Credit score
• Credit history and depth (number of open accounts, credit limits, payment history, public records)
• Down payment (loan to value ratio)
• Debt-to-income ratio
• Property type (SFR, condo, duplex, etc.)
• Occupancy (Owner, second home, investment)
• Cash reserves (amount of money in the bank minus down payment and closing costs)
• Income, including employment history and stability of income
• Type of income (salary, bonuses, commission, self-employment income)
• Payment shock (new payment versus current payment)

The system gives certain weight to each of these factors, some more than others.  Having a high credit score is All of these factors are important in determining the overall quality of a loan and the risk that it might result in a foreclosure or a slow pay.  Automated underwriting does not fully eliminate the need for an actual human underwriter to make a final loan decision, but is a helpful tool in determining risk. 

In certain situations, an automated underwriting denial may be overridden and manually approved by an underwriter.  This is known as "manual underwriting", and is quite common with government loans, such as FHA and VA.  Underwriters are typically allowed to use discretion to approve these loans as long as the loan meets certain guidelines (such as acceptable debt-to-income ratios and explanations for derogatory credit.)  In these cases, it's important to work with a lender who knows how to properly package a loan file and also document any special circumstances with the loan to have the highest chance of approval. The interest rates for manually underwritten loans are often higher because of the perceived higher risk of the loan and the fact that both the lender and the underwriter are sometimes taking a much greater personal risk by approving them. 

TYPES OF AUTOMATED UNDERWRITING:

Fannie Mae and Freddie Mac, who purchase around 95% of all Conventional Mortgages originated in the United States, have each developed their own automated underwriting systems.  Fannie Mae's system is called "Desktop Originator", or "D.O." for short, and Freddie Mac's system is known as "Loan Prospector", or "L.P." for short.  In addition, FHA has developed a program called "Total Scorecard", which has been integrated into both L.P. and D.O.  Many lenders have also developed their own automated underwriting systems, many of which incorporate Fannie and Freddie guidelines but have been modified to approve other loans they may choose to carry in their portfolio or reject certain loans that may meet Fannie/Freddie guidelines but don't meet the lender's specific arbitrary guidelines.  

An automated underwriting recommendation is only as good as the information that is input into the system.  In other words, if a lender obtains an automated approval based on information given to them by a borrower and discovers later that information is false or incorrect, this may result in a change in the approval status of a loan.  That's why it's always a good idea for a borrower to make full loan application and provide all documentation before an automated approval can really be trusted.   This is ESPECIALLY true for self employed borrowers and/or borrowers that have unusual types of income or anyone with a situation that might make loan approval difficult.  Additionally, the accuracy and validity of that information is verified by an underwriter.    

PRAISE AND CRITICISM:

Automated underwriting has been praised as a useful tool to both expedite the loan process and analyze risk factors more effectively.  However, many feel that the industry has relied too heavily on these models recently, and many lenders have been criticized for relying more on these models than overall common sense when it comes to analyzing risk.  Some automated systems have allowed borrowers with high credit scores to get loans with high, sometimes astronomical debt-to-income ratios to obtain loans, often with little or no compensating factors present to offset that risk.  And recently, many lenders such as Fannie Mae and Freddie Mac have tightened up their tolerances in their respective systems.