Last year’s two monster hurricanes aside, homeowners were making their mortgage payments at a better clip in 2017 than in any year in nearly two decades. But there are indications that borrower fraud and lender slip-ups could portend an increase in late payments, and possibly even foreclosures.
Fortunately, the upward trend in defective home loans is not likely to impact borrowers -- at least not directly, says Phil McCall, president of ACES Risk Management (ARMCO), which offers quality control services to lenders. But bad loans could have devastating consequences for mortgage producers, who could be forced to buy them back from investors who purchased them on the secondary market.
Only the uptick in misrepresentation is likely to be troublesome for borrowers. It is a federal crime to tell so much as a little white lie on your mortgage application. Borrowers who exaggerate their incomes and employment, fail to disclose their liabilities or falsify documents are rarely prosecuted, but it can happen. The greater worry should be that lying on your loan application could get you approved for a loan you’re not actually able to pay back.
ARMCO’s quarterly post-closing review of more than 90,000 loans, selected at random, found a surprising increase in the rate of critical defects in last year’s second quarter. A “critical defect” is any problem with a loan that renders it uninsurable or ineligible for sale. The most common loan defect found by ARMCO’s audit was in the “borrower or loan eligibility” category, which refers to loans that didn’t meet the rules of the investors who bought them. Typically in these cases, the lender either has to fix the problem or buy back the loan.
If the lender has to repurchase the loan, the impact could ruin them, especially if they’ve made more than a few bad loans. Most lenders aren’t well capitalized -- in a constantly repeating cycle, they make mortgages, sell them and use the proceeds to make more loans. So they don’t have the scratch on hand to buy back too many rotten apples.
Issues with credit, or the lack thereof, were the second most common defect in ARMCO’s survey. This relates to borrowers who, between the date they’re approved for a loan and the day they close, open one or more new credit accounts. Perhaps they purchased a slew of furniture for the new house, or took out a loan on a new truck to move said furniture.
Whatever the case, opening new accounts could push your all-important debt-to-income (DTI) ratio beyond the investor’s parameters. To guard against that, lenders are supposed to run a new credit report a day or two before settlement. But sometimes they don’t, and the bad loan slips through the cracks.
However, investors almost always perform quality control reviews on their end. And when they see that the DTI ratio has been exceeded, the lender will probably have to take the loan back. “Investors were burned enough during the 2008 downturn,” says McCall.
Consumers are on the hook for the next-highest category of loan errors found by ARMCO: mistakes about income and employment. Some borrowers will stretch a bit when they report their earnings or bonuses. Maybe they won’t report business expenses or losses, or perhaps they’ll say the rent they take in from their investment properties is greater than it actually is. In some cases, the borrower doesn’t report that he has to make alimony payments or payments on an unrecorded mortgage, either of which counts as a debt.
“Any type of misrepresentation on the part of the consumer could come back to bite him,” says McCall.
Sometimes, it’s the lender who flubs up by using outdated documentation or an inaccurate income history. Or maybe they didn’t properly source a large deposit in the borrower’s bank account, or validate that a gift from Mom and Dad was truly a gift, not a loan. In these types of errors, it’s the lender, not the borrower, who could pay dearly.
ARMCO isn’t the only firm that is finding a higher incidence of loan mistakes -- so has title insurer First American. Overall, First American’s defect index in December was down 18.6 percent from its high point four years ago. But it is up 20.3 percent from December a year ago. “Much of the elevated risk can be attributed to an increase in the share of purchase mortgage transactions, which tend to carry more risk,” reports the company’s chief economist, Mark Fleming.
And as mortgage rates rise, the share of purchase money loans will increase, “putting upward pressure on the overall risk of defect, fraud and misrepresentation,” says Fleming. “We have seen this before.”
But for now, home loans are performing admirably, according to Black Knight’s latest mortgage monitor.
While hurricanes Harvey and Irma significantly impacted loan performance, take them out of the equation and the national delinquency rate -- which covers 90 percent of the entire active mortgage universe -- was 11 percent below long-term norms in December, Black Knight found. Also, the number of seriously delinquent loans (90 days or more past due) was down 14 percent.
Better yet, 2017 was “a record-setting year” in terms of foreclosure activity, says Black Knight’s chief economist, Ben Graboske. Fewer than 650,000 loans started the foreclosure process last year, which is the fewest in any year since 2000.