Earlier this year, Fannie Mae’s Loan Quality Initiative (LQI) was announced and implemented. One aspect of the program requires a major change in the pre-closing process of many lenders and originators. This change is due to the need to confirm that no “undisclosed liabilities” or new credit have been established between the time of the loan application and closing, or the loan may be subject to buyback.
While this is not a new rule, Fannie Mae determined that the steps being taken to prevent problems related to this unforeseen liability have not been sufficient in the past, and is providing new urgency to assure that lenders or originators fulfill their due diligence on this issue or possibly face serious repercussions.
In a transaction with a wholesale lender, one must first determine who is going to handle the LQI requirements. This may be part of the lender’s preparation for closing, and not the responsibility of the loan originator; however, it can also be assigned to the loan originator and listed as a final condition prior to closing. Either way, the originator and the wholesale lender need to be on the same page as to whom is going to handle it and what type of due diligence is required by the lender to confirm that the consumer did not create any new liabilities.
When it comes to compliance with the credit reporting portion of the LQI, there are numerous options pending the lender’s desired preference of risk management. As of the time of this writing, Fannie Mae has not set specific standards that must be followed for this compliance, and in several communications with them, they have not indicated any plans to do so. Due to so many different interpretations on what is needed for risk avoidance, the credit reporting industry has stepped up to provide many options on services so that the lender is comfortable with the level of due diligence.
If the lender believes that having the consumer sign a document stating they created no new debts between application and closing, that is an acceptable practice. If the lender believes they need to “refresh” the credit report (as Fannie Mae refers to it) with a new credit report just prior to closing, that is also acceptable and seems to be the most common approach lenders are taking as it provides the greatest risk reduction. If the latter is preferred, now the quandary is, “How many credit repositories to access, weather to obtain new credit scores with the new file, and if the new file should be pulled with hard or soft inquiries?”
All variations of the above are acceptable, pending the amount of risk the lender wants to avoid. Since only mortgage transactions require multiple credit repositories, and the repositories do not share inquiry data from their files with each other, a simple way of looking at the risk is to estimate each of the national repositories to represent about one-third of the potential risk from new liabilities. If you access only one of the three national credit repositories for your “refresh report,” you are taking a chance of missing liabilities as roughly two-thirds of all inquiries will be missed by this practice. Add a second repository to your refresh report, and then you are two-thirds covered and only potentially missing one-third of the liabilities. The only way to cover all potential liabilities is with a three repository refresh.
This same formula applies to credit monitoring as well. Fannie Mae suggests that monitoring the credit report instead of actually accessing a full file may be a route to compliance. Just as above, if you’re only monitoring one of the national repositories, you’re still more likely to miss a new account than to discover it (pun not intended).
Regardless of the fashion of monitoring or refreshing the credit report, once a new inquiry is discovered, someone needs to contact the creditor listed to determine if a new account was actually opened from that new inquiry. This is a function that can be performed by the credit reporting company or the lender pending their interpretations on how to best comply. This is another area the industry has been quickly changing to meet the lenders’ needs. Several companies have come up with LQI solutions that offer a combination of refresh credit report and the investigation of any inquiries discovered.
Now the question of hard versus soft inquires and scores … If scores are accessed and are different from the scores at the time of application, there are issues associated with the change, and many of them could be fatal to the loan if the credit score has dropped below a fundable level. For that reason, many lenders have elected to not obtain credit scores with a refresh report. The downside to that would incur if the consumer has opened new liabilities which would require the loan to be resubmitted to Desktop Underwriter (DU). That would require another credit report.
This also applies to the question of hard versus soft inquires. If the inquiry is hard, meaning it will be on the consumers credit profile for all to see, and potentially impact the next credit score calculation, that file could be issued to DU (as long as scores where obtained too) if needed. Any refresh reports accessed with soft inquires, those only seen by the consumer with no impact on the credit score, are not re-issuable to DU.
One of the best methods of avoiding undisclosed liabilities from lurking in your files is a simple consumer education step. Make sure that the consumer understands at the time of the application not to apply for any new credit until after the loan is closed, and that there are quality control procedures to determine if they have that may kill the loan in the final hours prior to closing if they decide not to heed your warning. While this seems basic, many consumers get so thrilled about the quick approval that they think there are no other hurdles and immediately begin the process of buying the new furniture, home improvement materials, etc., and they may buy their way into a non-eligible loan status.
►For more info on Fannie Mae’s Loan Quality Initiative, visit Fannie Mae’s LQI homepage at https://www.efanniemae.com/sf/lqi/index.jsp.
►Fannie Mae’s LQI FAQ’s, see questions four through six at https://www.efanniemae.com/sf/lqi/pdf/lqifaqs.pdf.
Terry W. Clemans is the executive director of the National Credit Reporting Association Inc. (NCRA). He may be reached at (630) 539-1525 or e-mail [email protected]