Minimum Underwriting Standards: The First Stepby Tim Manni
At a financial seminar in Japan yesterday, Comptroller of the Currency John Dugan urged mortgage regulators around the world to institute minimum underwriting standards which every lender must adhere to.
“These standards would not dictate every underwriting feature of a mortgage product; instead, they would focus on core practices of sound underwriting on which there is the broadest consensus,” said Mr. Dugan.
“Each country has its own unique credit culture and different approaches to mortgage financing, and what works well in one might not work well in another,” Mr. Dugan said. “What I am suggesting, though, is that each country should articulate what those standards are for their lenders, and should report periodically on how well those standards are working.”
Here are three minimum standards Comptroller Dugan proposed for the United States:
1. Verification of Income and Documentation: No and low-doc loans were a contributing factor to the mortgage meltdown. Mr. Dugan says that these types of loans “invite misrepresentation and fraud.” Beyond that, “these mortgages materially distort the integrity of other underwriting standards that rely on accurate measures of a borrower’s income.”
2. Meaningful Down Payments: We’ve all seen the damage that falling home prices inflicted on borrowers with minimal equity. Borrowers with “no skin in the game” are much more likely to walk away from their homes. However, today’s strict down payment policies have had the opposite effect, keeping many credit-worthy borrowers from home ownership. “We will need to exercise great care in striking that balance,” he said.
3. The Ability to Pay Later: How often have we heard the trials and tribulations of borrowers who can no longer afford their mortgages because their monthly payments have risen? “Mr. Dugan said that borrowers qualified at the lower initial rate often couldn’t afford the higher payments. ‘That is the type of underwriting practice that generally should be prohibited, because it often implicitly relies on house price appreciation as the ultimate source of repayment of the loan – and as we have learned all too painfully in the last two years, house prices can certainly go down as well as up,’ he said.”
These standards could find a place within the proposed Consumer Financial Protection Agency, which is still receiving some debate in Washington.
Comptroller Dugan’s outline above shouldn’t surprise anyone. Collectively, they represent some of the normal, traditional underwriting standards which should have always payed a role in mortgage lending, but unfortunately did not. These ideas won’t seem overly restrictive to anyone who got a mortgage in the ’70’s, ’80’s, and much of the ’90’s, but perhaps to some of the folks who came into the market from 2003-2006.