Loan Zone: Secrets of the Cs
Keep your credit union on a safe and profitable course by knowing these “secrets of the Cs”—five underwriting red flags that signify your potential loan is 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 date. To consider capacity, you’ll want to look at the borrower’s employment, income and debt-to-income ratio. You’ll look at job changes, inconsistent hours, address consistency, paystubs, W2s, and IRS transcripts; all of these data points must match with the application.
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 including school loans, taxes, insurance and homeowners’ association dues are spoilers. You have to ask, is the borrower going to have a payment shock that will sink the loan?
In particular, pay close attention to paystubs so that you qualify an applicant based on a correct income figure. If anything is out of the ordinary—such as not having a breakdown of regular and overtime income on a year-to-date basis—lenders should proceed with caution. If the applicant’s monthly income is greater than the year-to-date monthly average or if the person’s employer shuts down Thanksgiving through New Year’s Day, the applicant’s actual income may be lower than it looks.
When it comes to capacity, concern yourself with three things: documenting a stable past, the ability to pay right now, and a dependable means 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. Models have been built that consider numerous variables, using thousands of actual consumers to predict future consumer behavior.
Red flags 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 such alternative credit data as utilities, rent, child care, cell phone bills, etc. This helps determine whether the member has a history of repaying. Disputed accounts and debt proven not to be the borrower’s are not included in the borrower’s profile or credit score. These must be removed in most cases, so ask questions.
When a co-signer or other contingent liabilities are part of the deal, the borrower must show complete and accurate evidence that the borrower is not obligated for repayment. In addition, 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.
Take the time to read the borrower’s entire credit report. Look at addresses, names and tradelines (lines of credit that have been in place for at least two years) to spot trends and to map his or her mortgage history. Also, does the applicant demonstrate an ability to access and appropriately use 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 checking/savings/money market accounts, stocks/mutual funds/stock options, gift funds, and earnest money.
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, broker price opinion or field/desk reviews.
Some concerns with collateral include unacceptable comparables, repairs needed or “subject to” disclaimers. If a property inspection reveals the property is in a disaster area, that’s not good. In addition, be aware of declining markets and the typically more volatile pricing market for condominiums. Both can spell trouble.
To properly navigate collateral and avoid red flags, determine the market value of the property. This determination is probably the most challenging task, as market value can be, according to the Uniform Standards of Professional Appraisal Practice (2010):
- based on an appraisal, a tax value or a real estate agent’s determination,
- stated as an opinion,
- presume the transfer of a property as of a certain date, or
- under specific conditions set forth in the definition of the term identified by the appraiser as applicable in an appraisal.
Do your 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. 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 these Cs and asking lots of questions. With experience and knowledge of the climate around you, you can safely navigate your credit union to safe and profitable lending.
Wallace Jones is VP/training at CUES Supplier member CU Members Mortgage, Addison, Texas.