REAL ESTATE FINANCE
Ninth Edition
John P. Wiedemer and J. Keith Baker
Chapter 14
Technology Advances in
Mortgage Lending
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LEARNING OBJECTIVES
At the conclusion of this chapter, students will be able to:
• Describe the key supporting technology tools for residential loan
origination.
• Understand the origins, uses, and evolution of automated credit scoring
technologies and vendors.
• Describe how advanced data repositories and automated systems aided
in the development of the subprime loan market and enumerate the
lessons learned from that overreliance on modeling.
• Explain the various ways that internet lending has changed the way
lenders and borrowers approach the pricing, marketing, and closing of
residential mortgage loans.
• Describe the various online real estate services.
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Introduction
• Computers make it possible for financial institutions to convert
mortgage pools and their cash flows into mortgage-backed securities.
• New software has been developed to analyze loan applications and give
recommendations for loan approval, if justified.
• Decisions on loan applications can be made with much greater speed.
• Technology brings greater depth to the analysis of the creditworthiness
of borrowers.
• Increasingly larger databases allowed the development of additional
loan products.
• Unfortunately, computer models did not capture all the true risks.
• As a Lehman Brothers employee commented, “Events that models
predicted would happen only once in 10,000 years
happened every day for three days.”
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Computerized Loan Origination (CLO)
• Used as a method of transmitting information between computer
terminals for analysis by human underwriters.
• A controversy developed between the Mortgage Bankers Association
(MBA) and the National Association of Realtors (NAR).
• The MBA saw an intrusion into its specialized field of mortgage loan
origination by real estate agents who had first contact with a buyer.
• The MBA’s position was that RESPA prohibited a real estate agent from
making a fee for a loan, which might be a kickback and that such action
amounted to “steering” the buyer to one lender.
• Over the years, mortgage brokers and real estate agents found that by
working together it was possible to increase their sales by allowing
both parties to earn a portion of the origination fee.
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Computerized Loan Origination (CLO)
• Real estate agents must be aware of specific guidance from HUD.
• HUD will look at the specific facts of each case, including:
(1) whether certain work must be performed in order to earn a fee.
(2) whether such work was actually performed.
(3) whether the services are necessary for the transaction.
(4) whether they were duplicative of services performed by others.
• In the past, HUD generally would be satisfied that if a real estate agent:
(1) took information from the borrower and filled out the loan app.
(2) performed at least five additional items on the Services List.
(3) received a fee reasonably related to the value of the services.
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Computerized Loan Origination (CLO)
The HUD Services List is as follows:
a.
b.
c.
Taking information from a borrower and filling out an application.
Analyzing borrower’s income & debt to determine maximum mortgage.
Educating a borrower in the home-buying and financing process,
advising about the different types of loans, demonstrating how closing
costs and monthly payments would vary under each product.
d. Collecting financial information and other related documents.
e. Initiating/ordering verifications of employment and deposits.
f. Initiating/ordering requests for mortgage and other loan verifications.
g. Initiating/ordering appraisals.
h. Initiating/ordering inspections or engineering reports.
i. Providing disclosures (truth in lending, good faith estimate, others).
j. Assisting a borrower in understanding clearing credit problems.
k. Maintaining regular contact with borrower, realtors, and lender between
application and closing to apprise them of status of application and to
gather additional information needed.
l. Ordering legal documents.
m. Determining whether property is in a flood zone.
n. Participating in the loan closing.
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Computerized Loan Origination (CLO)
• Real estate agents utilizing a CLO system, now called manual
underwriting, are generally resorting to intermediary companies.
• By sending information on a borrower to the intermediary, the real
estate agent is prompted if all information has not been submitted.
• Intermediary has contacts with lenders and may place loans quickly.
• An origination fee split is negotiable between the intermediary & agent.
• If there is an ownership interest of 1% or more in the CLO, it is
considered a controlled business arrangement and must be disclosed.
• There can be no required use of the affiliated company and nothing of
value may be given the affiliate other than a return on ownership.
• To pay the agents, mortgage companies often allow a yield-spread
premium.
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Loan Origination Systems
• LOS has been developed to support the loan processing needs of
banks, financial institutions, and the mortgage brokerage community.
• It employs workflow technology to control the steps in loan processing
and reduces the inefficiencies involved in handling paper documents.
• LOS will allow work steps to be performed in different locations,
(through the “cloud”) while maintaining control of the work flow.
• With cloud computing, software is no longer loaded on local computers
or a server that require maintenance and support.
• The only thing the user’s computer needs is the cloud computing
interface software, (Mortgage Marvel) which is accessed via the Web.
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Automated Underwriting Systems
• More advanced use of the computer has been developed by as more
experience and better technology has become available.
• Freddie Mac and Fannie Mae introduced separate automated
underwriting systems for use by their seller/servicers.
• Each has advanced software capable of analyzing a loan application
and approving it for funding if qualifications are met.
• Other lenders produced their own systems to analyze loan applications.
• The Federal Reserve Bank Board system, called Partners, tells a
potential borrower if he or she qualifies for a mortgage loan.
• It is designed to help professionals assist low- and moderate- income
borrowers, but is accessible to anyone seeking help.
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Freddie Mac’s Loan Prospector
• The information submitted is that required by the Uniform Residential
Loan Application (Freddie Mac Form 65).
• The initial charge for an analysis was $100; now it is $20.
• Verification of employment, income, and assets is required.
• If the LTV is greater than 80%, the application is forwarded to a private
mortgage insurer chosen by the lender.
• One of the following recommendations will be returned on the Full
Feedback Certificate: (1) Accept, or (2) Caution.
• Credit reports merge information from at least two of the three major
databases.
• A collateral assessment determines whether or not the collateral is
sufficient to secure the loan.
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Fannie Mae’s Desktop Underwriter
• DU uses artificial intelligence and information from Fannie Mae’s
seller/servicer guide to properly analyze a loan application.
• Desktop Originator® (DO), allows one to take an application in a
potential borrower’s home with a laptop computer.
• Information must come from the Uniform Residential Loan Application
(Fannie Mae Form 1003, Freddie Mac Form 65).
• Lenders must verify information and submit it through DU after which a
response can be provided within one minute on “approved” applicants.
• Streamlined property valuation through DU can save borrowers time
and money and can help lenders manage the valuation process.
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Fannie Mae’s Desktop Underwriter
• DU will have tie-ins with automated closing and documentation
systems that meet electronic signature and recording requirements.
• Trade associations have already introduced SMART Doc® Framework.
• The following terms make up the acronym.
Securable
Manageable
Achievable
Retrievable
Transferable
• The system will need tamper-evident security and provide an audit trail
of any changes.
• Lenders continue to manage the property appraisal process through
DU, including selecting the appraiser, ordering the appraisal, and
reviewing the appraisal report.
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Credit Scoring
• A snapshot that objectively assesses a borrower’s credit history.
• A credit score may vary somewhat across repositories.
• A credit score may be generated even if a file includes only one
tradeline, so lenders try to make sure that multiple files are included.
• Today, credit scoring is offered using two major methods.
• One is the FICO score that runs from about 350 to 900.
• The other is the “bankruptcy score” which runs from about 0 to 1,300,
with the higher number showing a greater risk of default.
• Credit scoring is used in conjunction with other criteria, such as an
applicant’s income, assets, total indebtedness, and future possibilities.
• It is seldom used by itself for underwriting purposes.
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Subprime Loans
• Made to persons who do not have top-grade credit.
• Automated underwriting is one reason that lenders do subprime.
• Subprime loans command higher interest rates and discounts.
• Using risk-based pricing where rates are negotiated to fit the risk.
• The underwriter does not examine whether or not the borrower is
worthy of credit, but where the borrower belongs on the risk scale.
• Credit scoring is a helpful factor in this determination.
• The borrower is matched to one of a series of risk profiles.
• Comparisons can be made to “A” borrowers with a default rate of 7.8%.
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Subprime Loans
“A” borrower:
No late mortgage payments and no credit card payments over 30 days
delinquent in the last year. Delinquency rate is 7.8%.
“A-“ borrower:
Referred to as Alternate A mortgages. No late mortgage payments and
one or two credit card payments 30 days late. Delinquency rate is 26%.
“B” borrower:
30 days late on a mortgage and 60 days on one or more charge accounts.
Satisfactory credit but high debt ratios. Delinquency rate is 36%.
“C” borrower:
30 days late 2-3 times on a mortgage and several charge accounts 60
days late. Only fair credit and high debt ratios. Delinquency rate is 36%.
“D” borrower:
Has poor credit and high debt ratios. Lender must depend on the
collateral to guarantee repayment. Delinquency rate is 51%.
“F” borrower:
Currently in bankruptcy or foreclosure.
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Mortgages on the Internet
• Most active mortgage loan companies and financial institutions have
websites that offer mortgage loans directly to consumers.
• Many applicants live in rural areas and want to avoid traveling.
• People pressed for time look to the Internet to expedite the process.
• People with tarnished credit do not have to face a skeptical loan officer.
• People with good credit sometimes like to avoid face-to-face apps.
• Studies show that consumers shop for the best price and terms, but
even sophisticated borrowers find it difficult to effectively shop for
mortgages.
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Mortgages on the Internet
• Often have lower origination fees, perhaps 3/8 of a point compared to 1
to 1 1/2 points with regular mortgage brokers.
• Other fees and interest rates are about the same as regular mortgages.
• There is a problem in not having a real person with whom to talk to.
• The Internet has its share of shady operators.
• But there is no denying the growth in Internet mortgage originations.
• The top 22 mortgage lenders in 1999 only reported a little over 13,000
online mortgages for a total of $4.7 billion in mortgage production.
• The top online originator in the first quarter of 2010 originated double
the number originated by the top 22 online lenders in all of 1999.
• Online mortgage originators fall into three categories…...
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Mortgages on the Internet
1. Direct lenders.
Actually fund the loan. They exist at the national, state, and local levels.
Local mortgage loan originators can function as online mortgage lenders
just by having a website with an application form on it.
2. Mortgage brokers.
Mortgage broker give customers access to a wider availability of lender
programs and loan options. Most have a basic online mortgage website
from which they can take mortgage loan applications.
3. Lead generators.
Also referred to as referral websites, these specialize in generating leads
from borrowers and then passing those leads along to one of the direct
lenders. Considered the most effective tool used by both direct lenders
and mortgage brokers.
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Mortgages on the Internet
• It has become easy for loan originators of any size to have some basic
online loan origination presence.
• Software applications such as PG Mortgage Software are available to
individual mortgage brokers.
• This software combines features, such as LOS-application tracking,
that are compatible with Calyx Point and Fannie Mae LOS with the
ability to export application forms to these well-known programs.
• Moreover, the software has site security with SSL Certification.
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Online Real Estate Service
• Many companies offer an online real estate service that allows
consumers access to information on a full range of services.
• In 1998 the software giant Microsoft stepped into this arena.
• Microsoft offers a service that lets you search for homes, find builders,
compare mortgage products, and apply for loans.
• Real estate professionals have created products that allow brokers to
create the image of a broad market online real estate service.
• Companies offering these services deny any intention to replace
existing agents.
• To close any deal, the consumer must contact an agent.
• The following web sites offer an idea of just how diverse is the
information offered on the Internet.
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www.argussoftware.com
• The leading provider of software and solutions for analyzing and
managing the value of real estate investments worldwide.
• ARGUS Software has a world-class user base consisting of over 9,000
users and has been focused solely on commercial real estate.
• A trial version of ARGUA Valuation – DCF has been provided with this
text to allow the reader to learn how to use ARGUS DCF.
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www.bytesoftware.com
• Byte Software’s flagship product is BytePro Standard, a comprehensive
loan origination software package that allows a loan originator to
prequalify, originate, process, and close loans.
• Byte offers six expansion versions of its mortgage LOS system to meet
the needs of larger and more demanding technology platforms,
including the Internet and security packages.
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www.calyxsoftware.com
• Calyx is most well known for its Point loan origination platform.
• According to a 2010 study conducted by Access Mortgage Research &
Consulting, 72.5% of mortgage brokers reported using Calyx Point.
• Loan Origination Systems (LOS) are also utilized by community banks,
credit unions, and mortgage bankers, and can be used with DU and DO
along with several other vendors mentioned earlier in the chapter.
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www.ditech.com
• Ditech was founded to address the needs of customers for faster,
easier access to mortgage loans.
• Ditech has emerged as one of the larger online mortgage loan
originators.
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www.eloan.com
• Offers prequalification and preapproval for home equity loans as well
as first mortgages and refinancing.
• The site has a link that helps users compare values of different homes
in a given neighborhood.
• It even has a feature that allows the user to hold out for a particular
interest rate and to receive an e-mail when the rate becomes available.
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www.hsh.com
• HSH Associates surveys 2,500 lenders across the country and
provides updates daily.
• It does not make loans or accept limited consumer advertising, which
makes it an excellent source of objective data on rates and terms.
• It makes the bulk of its revenues from lead generation.
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www.mortgagebot.com
• Its Powersite Suite of programs provides affordable, easy-to-use, and
secure technology solutions fully integrated with most LOS software.
• This product can be deployed with surprising speed.
• Completely Internet-based with no software or hardware to install.
• Mortgage Marvel is an Internet based solution for smaller lenders who
want to expand past their traditional base.
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www.mortgagebuilder.com
• Providing a fully integrated server-based application for a wide base of
possible needs in the mortgage finance business.
• Delivering prequalification tools, processing, underwriting, closing,
post-closing, document tracking, secondary marketing, warehousing,
delivery, interim servicing, and construction loan tracking.
• Pricing and product eligibility, electronic document management, and
electronic loan delivery functionality for the GSEs are built in.
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www.phhmortgage.com
• Among the top five residential mortgage originators.
• Its online business consists of the firm’s own retail mortgage
operations.
• PHH is also the leading provider of private label mortgage outsourcing
to companies that want to have an online loan origination presence
without the cost of the technology development, staff training,
recruiting, and other barriers to entry for many smaller lenders.
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www.provident.com
• The largest private mortgage company in the United States.
• One of the top five direct online lenders for the past three years.
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www.rcanalytics.com
• Real Capital Analytics, Inc. is a global research firm focused exclusively
on the investment market for commercial real estate.
• Offers comprehensive, current information of activity in the industry by
collecting transactional information for property sales and financings.
• Interprets data such as cap rates, market trends, pricing and sales
volume.
• Quantifies the market forces and identifies the trends that affect the
pricing and liquidity of commercial real estate around the world.
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Using Computerized Information in the Future
• Indications are that mortgage loans will move to a risk-based mortgage
pricing system where lenders assess borrowing costs loan by loan.
• This will be possible with computerized loan evaluation systems
capable of forecasting the default risk dictated by each applicant.
• Secondary-market companies will be able to adjust the guarantee fees
to more accurately reflect the risks within a loan pool.
• Lenders may pass the distinctions on to borrowers in the form of
similarly varying mortgage fees.
• The adoption of automated underwriting systems gives the lending
industry the ability to measure risk more quickly and accurately.
• For years, the country’s main residential market has relied primarily on
average cost pricing.
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Using Computerized Information in the Future
• Every mortgage interest rate includes a premium to cover the risk of
default, with all prime borrowers paying the same interest rate.
• With risk-based pricing, the alignment of risk and reward is more
closely met by giving lower interest rates to less risky borrowers.
• Future mechanically determined, more accurate risk assessment may
lead to a universal account that could make mortgages obsolete.
• The idea would be a combination of loans, such as a car loan, a
personal loan, or a mortgage loan, into one loan account.
• Financial institutions are already moving in this direction, recognizing
the value of cross-selling products.
• The financial supermarket entered into by many financial services firms
may become more of a reality due to current and future advances.
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Questions for Discussion
1. What is HUD’s position on computerized loan origination?
2. Explain what is meant by manual underwriting and automated
underwriting.
3. Describe the principal features of Freddie Mac’s Loan Prospector.
4. What does Fannie Mae offer in terms of automated underwriting?
5. Explain how credit scoring operates.
6. Describe the loan risk ratings within which subprime loans fall.
7. Explain the three categories of Internet mortgage originators and how
they differ in approach.
8. Describe the kinds of people who may want to arrange mortgage
loans through the Internet.
9. Describe the dominant online mortgage originators and real estate
online offerings and list the key online players today.
10. Describe risk-based pricing as it applies to mortgage loans.
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