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Home Equity Due Diligence
ASG has extensive experience in the due diligence, structuring, valuation and marketing of single-family portfolios, including Home Equity loans. As 125 LTV Mortgages emerged as a major growth area in the home equity asset-backed securitization market, ASG has performed an increasing number of due diligence projects for this sector.
Underwriting: ASG customizes the loan file review to the lender's established guidelines used to underwrite and decision the loans. Normally, a statistically valid sample of loans is re-underwritten in accordance with the lender's guidelines. Adherence to the lender's published guidelines is essential in evaluating a portfolio in addition to establishing the data integrity of the loan level information provided by the lender. Guidelines should address the borrower's credit score, debt to income ratio and bankruptcy history. These guidelines typically dictate allowable loan size, amount of cash out and interest rates in each credit score range. ASG also determines if the lender's credit grades require a uniform mortgage payment history across board. For example, typically, one 30-day late mortgage payment in a given year is permitted no matter what the grade. Prompt payment performance displays the borrower's commitment and willingness to make the mortgage payment before other debts. Typically, with an HLTV loan a lender consolidates other payments with the HLTV loan in order to lower the borrower's total monthly outlay.
Analyzing Exceptions:ASG identifies exceptions to the guidelines -- such as, minimum credit scores not met, maximum debt ratios exceeded, CLTV exceeded for specific programs -- and determines why the exception was granted and if the necessary authorizations to override any exceptions were in place. ASG verifies the compensating factors that were considered in the approval of an exception. An important document that ASG thoroughly examines is the HUD-1 statement to determine which debts were paid off and if all debts that were required to be paid off as a condition for approval were, in fact, paid off through closing.
The Importance of Sound Underwriting: Sound underwriting is essential in all home equity lending however especially with HLTV loans. Basically, an HLTV loan is an unsecured junior lien where losses cannot be recovered through the sale of the property. The lender must rely on three elements of the borrowers willingness and ability to repay: the borrower's credit score, previous mortgage and credit payments histories and the ability to repay as measured by the debt to income ratio.
Repository Credit Scores: HLTV loans, in a departure from the accepted conventions of home equity lending, which dictate that the mortgagor must have equity in the home, favor a lending model that approximates unsecured lending products. The 125 LTV model stresses the mortgagor's credit performance and relies heavily on credit scores. An HLTV lender will take the credit score (the primary determinant of the borrower's credit grade) from the preferred repository for a particular state or use the middle of three approaches. As previously mentioned, a 125 LTV lender will generally require uniform mortgage payment histories across the credit grades. Debt-to-income ratios and other measures of the borrower's ability to repay take on a greater significance, as erosion in the borrower's ability to pay is likely to be the primary cause of default in an economic downturn.
The credit score alone should not be used to render a lending decision. Some providers of credit, including mortgage lenders do not report to the repositories. A thorough credit analysis must be performed including the verification of the mortgage payment history. An underwriter must also keep in mind that the credit score often trails the reporting of individual accounts that might contain recent derogatory information, including judgments and tax liens. The score can take a few months to catch up with the histories. Another aspect of the credit analysis is recent debt payoffs. This could indicate a previous debt consolidation that would inflate the current credit score. A borrower's credit score usually increases as a result of a reduction in revolving debt. In one case, a borrower had a credit score of 660 and in June took out a 125 LTV loan to pay off credit card bills. The borrower's overall monthly payments declined from $600 per month to $470 and his credit score increased to 710. Three months later another 125 LTV lender offered the same borrower the opportunity to refinance this loan at a lower rate saving him an additional $40 per month. The lender was able to offer the lower rate due to the higher credit score. This borrower is not as strong as a borrower who has a 710 score based on consumer and mortgage payment history. This is commonly referred to as churning by lenders and will also affect prepayment rates.
Conventional Home Equity Loans: With regard to a conventional home equity loan, an appraisal would be obtained and the underwriter would perform a thorough analysis. This is essential in determining the CLTV. Interest rates are determined by CLTV and credit scores. If a lender has an overstated value then he has an under-priced, riskier loan. In addition, a conventional home equity loan relies on the sale of the property to recover losses. If the value is overstated, the proceeds of the sale will be insufficient to recover losses. As opposed to 125 LTV loans the debt ratio carries less overall weight than the credit scores and the CLTV in conventional home equity lending.
Reporting:ASG's report package contains loan level and aggregate reports. ASG transmits the final due diligence data via electronic media to the customer's location, in the customer's preferred software and layout.
Home Equities - Market Background: In general, Home Equity Lending was made popular by the elimination of consumer interest as a tax-deductible expense. The 125 LTV loan essentially evolved from the FHA Title I program.
The FHA Title I program had its pluses and minuses. The plus side included the benefit of FHA insurance that protected the lender against limited losses and no CLTV limit. The minuses were extensive paperwork, limited loan amounts, the proceeds were exclusively for home improvements and because it was a government program, the borrower's credit quality was mixed.
Lenders then created their own home improvement loan programs to avoid the size limitations and their awareness of the value of home improvement loans versus other types of equity lending. These loans generally went up to a CLTV of 125% and required that funds be disbursed directly to the vendors.
The next stage in the product evolution was the debt consolidation loan. The 125 LTV debt consolidation loan allowed lenders to make debt consolidation loans to borrowers with a relatively high LTV on their first mortgages, generally between 85% and 90% bringing the CLTV up to a maximum of 125%. The advantage to the consumer was to reduce their monthly outlays and take advantage of the tax deduction for mortgage interest.
The next category in the 125 LTV loan was the combination of debt consolidation and a limited amount of cash out. This category represents the bulk of the 125 LTV program today, although some lenders have a combination of debt consolidation and home improvement.
The last program to arrive in the marketplace that seems to be disappearing is the all cash-out program. Loan amounts are as much as $150,000 and require the borrower to have a relatively high minimum credit score and a good prior mortgage payment history.
The attributes of the 125 LTV borrowers mirror those of the "A/A-" borrower. Credit scores fall in the 670 to 680 range, their average age is in the late 30's to early 40's, residency is established for four to five years, household income is around $60,000 with some at $70,000, most are salaried borrowers as opposed to self employed and finally, back end debt to income ratios after the 125 LTV loan are between 35% and 40%.
Two of the major concerns of this type of lending are "churning by lenders" which was previously mentioned and results in an inflated credit score and "reloading" by the borrowers. "Reloading" is defined as the borrower's rebuilding of new revolving debts or "reloading" of the borrower's credit cards following reduction of his overall payments through the 125 LTV loan. In this situation, the borrower's overall debt burden relative to income could rise and erode the borrower's credit profile. Some lenders have elected to periodically re-score portfolios and use the revised credit scores to determine the direction the credit profiles of their borrowers have taken.
Another concern to lenders and investors is the impact on HLTV product of an economic downturn. Should a borrower become unemployed during a recession, his or her ability to repay would be seriously impaired.