Keep your credit union on a safe and profitable course by knowing these Secret of the Cs – 5 underwriting red flags that signify your potential loan is going down as a sinking ship.
What are the Cs? They are key factors that should always be considered and reviewed with care to identify your loan’s potential.
Capacity is the borrower’s ability to repay a debt by its final maturity (ATR/QM). This is the borrower’s employment, income, and debt-to-income ratios. You’ll look at job changes, inconsistent hours, address consistency, paystubs, W2s, IRS transcripts, and all of these and the application must have matching amounts.
Self-employed borrowers are increasingly scrutinized because of their nebulous work-life. Commissions, bonuses, and overtime income are looked at carefully.
The big red flag is the debt-to-income ratio. Outstanding expenses that include school loans, taxes, insurance, and HOA dues are spoilers to spot. You have to ask is the borrower going to have payment shock that will sink their loan?
In particular, pay close attention to the paystubs. If there is no breakdown of regular and overtime income on a year-to-date basis, lenders should proceed with caution. The same goes if their monthly income is greater than year-to-date monthly average and if their employer shuts down Thanksgiving through New Year’s Day.
When it comes to capacity, concern yourself with three things: documenting a stable past, ability to pay right now, and a dependability to provide payment in the future. If these items look solid, you are on the right track to approving the loan.
Credit is the statistical analysis of the borrower’s likelihood to repay the loan. Statistical models have been built that consider numerous variables, and combinations of variables, using thousands of actual consumers to predict future consumer behavior.
Red flags regarding credit to identify include “thin” credit. If a borrower has little or no credit, then there may not be enough data to evaluate the borrower’s credit history or even to calculate a score. In those cases, borrowers might be asked to provide alternative credit data such as utilities, rent, child care, cell phone bills etc. This helps determine whether the member has a history of repaying their debt. Disputed accounts and debt proven not to be the borrowers are not included in their profile or credit score. These must be removed in most cases. So ask questions.
If the borrower has a co-signer or other contingent liabilities, they must show complete and accurate evidence that the borrower is not obligated for repayment. In addition, the obvious foreclosures, bankruptcies, deeds-in-lieu, or any short sales cannot be overlooked. Lastly, all new credit, such as inquiries, new accounts, or undisclosed debts, must be verified and added to the loan application for overall approval consideration.
When navigating the borrower’s credit report, it would be in your best interest to take the time to read the entire report. Look at addresses, names, and tradelines to spot trends and to map their mortgage history. Also, does the applicant demonstrate an ability to manage their access and use of credit? If not, this application is sink, sank, sunk.
Cash is defined as depository and non-depository assets that are acceptable sources of funds for down payment, closing costs, and reserves. Some of these sources include Check/Savings/Money Market Accounts, Stocks/Mutual Funds/Stock Options, Gift Funds, Earnest Money, and any Paid Outside of Closings.
Documentation is a must to show where the money came from and it must be accurate. Gift funds must be verified. Earnest money must clear the account. Large deposits must be documented and explained.
The point is to verify ownership of all funds and align all verifications with similar time periods for all accounts.
Collateral is real property that a borrower offers a lender to secure a loan. To ensure the collateral’s accurate value, you must conduct an appraisal, automated valuation, property inspection waiver (PIW), or BPO/Field/Desk Reviews.
Some concerns with collateral include unacceptable comparables, repairs needed, or “subject to” disclaimers. Also, if a property inspection reveals the property is in a disaster area, that’s not good. In addition, be aware of declining markets and condominiums. Both spell trouble.
To properly navigate collateral and avoid those red flags, you need to determine “market value” of the property that will be used in exchange. This determination is probably the most challenging task, as market value can be, according to USPAP (2010):
- a type of value
- stated as an opinion
- that presumes the transfer of a property
- as of a certain date
- under specific conditions set forth in the definition of the term identified by the appraiser as applicable in an appraisal
In addition, do your own homework. What you don’t know – will hurt you. Visit such sites as Zillow, Google Earth, and other appraisal review locations to gain a clearer, more accurate picture of properties and the surrounding area’s value.
The last “C” is character. You can determine this trait through strategic inquiries, along with your experience and intuition. Also, ask yourself, is the transaction characteristic? Does something stand out as odd, unusual, or suspect? If you are unsure, ask an experienced fellow employee or your superior. Better safe than sorry.
Underwriting requires paying close attention to those Cs and asking lots of questions. With experience, expertise, and knowledge of the climate around you, you can safely navigate your credit union to safe and profitable lending.