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Director of Corporate Relations Freddie Mac

An increasing number of consumers have benefited from the speed, accuracy and fair treatment provided by the use of credit scoring and automated underwriting over the last several years. In addition to summarizing these benefits, we describe how automated underwriting and credit scoring benefit the consumer during the mortgage application process.

American families now enjoy more choice and opportunity in the mortgage market than ever. Home-buying families can choose a mortgage product that meets their specific financing needs—and they can do so by telephone, on the Internet or in a face-to-face transaction. Loan approval procedures, which once took many weeks, now take days. The once time-consuming credit review process now takes place in minutes, thanks to technologies that have automated the underwriting process.

Manual underwriting characterized the mortgage market before the 1990s. This slow process provided only a limited ability to analyze multiple risk factors and sift through layered risks. Without the ability to precisely measure distinctions in risk with speed and accuracy, lenders and investors developed guidelines that broadly defined creditworthiness. For decades these guidelines served well the vast majority of mortgage borrowers in what came to be known as the prime market.

Over the years, easier access to credit and a rising bankruptcy rate meant that an increasing number of borrowers with blemished credit histories fell outside the mainstream that the industry's typical guidelines were able to address. Some did not get mortgages. Some resorted to the subprime market. In either case, potential borrowers could not take advantage of the efficiencies available in the prime sector.

Now, powerful tools are fundamentally changing the market's ability to assess and manage credit risk. Automated underwriting now makes it possible to extend the efficiency of the prime market to those who (until now) have been beyond its reach.

Instantaneous and Accurate Risk Assessment

Automated underwriting is one of the keys to opening new doors of opportunity, because it allows for the instantaneous and accurate assessment of a multitude of risk factors. Freddie Mac has led the development of this critical tool, by introducing the state-of-the-art automated underwriting service, Loan Prospector® (LP), in 1995.

The predictive power of automated underwriting helps lenders and borrowers alike. It gives lenders the tools they need to make more mortgages and reach out to new borrowers. It gives consumers confidence that mortgages are evaluated the same way, every time, for every borrower, encouraging more borrowers to enter the housing finance system.

borrower is African-American, Hispanic or white, loans in the lowest-risk groups performed significantly better over time than those in higher-risk groups. Because it is blind to an applicant's race and ethnicity, LP promotes fair and consistent mortgage-lending decisions. Moreover, LP predicts well across income groups and neighborhoods. Automated underwriting reduces the need to prescreen mortgage applicants.

Automated Underwriting Revealed

Automated underwriting is necessary to provide a full picture of mortgage eligibility. Automated underwriting is faster and fairer than manual underwriting and provides a more precise evaluation of risk. Credit is a very important part—but just a part—of the evaluation process. Credit scoring is the fastest and fairest way to evaluate credit. It has proven to be predictive for all population groups. Credit scores evaluate previous credit performance, the current level of indebtedness, the length of credit history, the types of credit in use and the pursuit of new credit.

Automated underwriting benefits consumers when applying for a mortgage in several different ways.

Access to the System: Consumers should not be rejected during a quick preapplication screening. Lenders should conduct a full analysis of their homeownership potential. Freddie Mac discourages lenders from using credit scores as a screening device because it does not provide a full picture of the borrower's ability to pay a mortgage. LP considers credit, collateral and capacity but does not consider race, age or marital status, and thus, it can provide a fair and thorough evaluation of the mortgage in a few minutes.

The proof of any underwriting system lies in its ability to assess risk—and LP has proven to be highly predictive of default for borrowers from all racial and ethnic groups and all types of neighborhoods. Whether a

Objective Sources of Information: Consumers should have access to credit counseling to help them understand the risks and rewards of homeownership and to assist them in getting their mortgage application approved. Freddie Mac supports AHECI, NAACP and the national Urban League as well as other organizations that provide homeownership and financial literacy counseling. Consumers can request their credit reports before applying for a mortgage to check the accuracy of their credit information. Consumers have the right to correct the credit information LP uses in evaluating credit history.

Full and Fair Information: Interest rate, payment amount, adjustable rates, late fees and prepayment penalties need to be explained and understood. Freddie Mac requires lenders to follow fair credit and fair lending laws and also requires lenders to report when borrowers do pay their bills on time, so borrowers can get credit for a job well done.

Fair Lending Practices: If borrowers are eligible for "A" mortgages, lenders should charge "A" mortgage rates. Freddie Mac's LP provides the lender with the lowest-risk mortgage rate regardless of the lender's classification of the mortgage.

Explanation for Mortgage Denial: Lenders should provide borrowers with information that can guide them to improve their chances for acceptance. LP does not deny a mort gage application. On higher-risk loans, LP requests additional support documentation and requires the lender to share some of the higher risk. Alternatively, LP offers to purchase the loan with additional fees to compensate for the additional risk. In any case, LP provides the lenders with feedback to guide them in improving their application.

For example:

  • If tax returns are used to document source of income or to verify income, obtain signed IRS forms from borrower; or
  • Use stated income for qualification and obtain most recent year-to-date paystub to verify employment for borrower.

In addition Fair, Isaac scoring products also provide up to four reason codes, in order of importance, that indicate why a score is not higher. For example, "derogatory public record or collection filed," or "amount owed on accounts is too high."

While the techniques for evaluating risk have advanced, the general rules for improving your credit and your ability to obtain a mortgage remain the same:

  • Pay your bills on time;
  • Keep your credit card balances low; and
  • Make sure your credit records are accurate.

Using credit scoring as part of automated underwriting helps more borrowers get mortgages because of the speed, accuracy and fair treatment inherent in these tools. If the alternative is manual underwriting, there is no comparison.

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