     douglas pratt (Dougpratt) | Monday, April 16, 2001 - 07:37 pm 
there often arises some confusion about what role FICO scoring plays in the underwriting of fannie mae & freddie mac mortgages. setting shortcomings of FICO itself aside for the moment, i'm starting this thread with an explanation of how these loan programs work, and the mechanics involved in both traditional and automated underwriting procedure.
when a lender grants a mortgage, they are loaning the borrower enough cash to purchase or refinance a piece of real estate. that money has to come from somewhere; at closing the seller or previous lien holder is paid in full and walks away.
in return for cash, the lender takes a promisory note from the borrower. this is collatoralized by the property itself-- if payments are not made as agreed, the lender can take title to the property in lieu of performance.
a promisory note is a saleable asset. if a lender wishes to convert its principal value into liquid [cash,] the note can be sold to any third party. as long as the borrower continues to perform, the new note holder receives payments under the exact same terms and conditions as when it was written.
for decades, fannie mae and freddie mac, "quasi-gevernment agencies" as one of my attorneys calls them, have made home ownership easier to attain and far more affordable than could your friendly neighborhood banker, due to the structure of the system they employ. think of it like buying a VCR from a national chain store as opposed to mom and pop video 4 blocks up the road in Central Square.
first things first- when a bank writes mortgages, this doesn't necessarily mean that they intend to keep the notes in their loan portfolio. when they can get 18% from credit card customers, why hold on to something returning only 7% per year? banks survive and thrive on the differntial in interest rates between that they pay people lending money to them [savings accounts, fed funds), and what people borrowing that same money pay them, month in, months growing to years, etc..
the money backing EVERY fannie mae or freddie mac loan comes from poold of largest scale investors who place billions into bonds guaranteed to yield specific returns, whether for a limited period of time [adjustable], or until maturity [usually 15 or 30 years], corresponding to the terms of fixed rate mortgages.
ALL fannie mae/freddie mac mortgages as sold into these investment pools. whoever actually writes a fannie/freddie note is irrelevant; money they are committing is that of the bond holders, not their own. they receive a commission for administration and customer services as the note passes through their hands. traditionally, it is the duty of the banker and underwriter to evaluate and approve a loan based upon the borrower's merits and overall profile of the request: loan to value, cash flow, past performance, and actions taken if financial difficulties may have arisen before.
once approved by underwriters [and bank president if things aren't really solid], the loan would be letter-graded and sent to bond analysts who place quantities of loans into packages based on length of term, viability of performance, and conformity by dollar amount and type of property-- borrowers exceeding a specified dollar amounts pay more for a "jumbo" loan, and there must be a minimum ratio of owner occupant:to:investor in most condominium associations. traditionally, "jumbo" notes carry slightly higher interest rates, as do "no-income verification" loans for self-employed borrowers, who must rely upon equity and past performance to present a strong profile to a prospective lender.
once written, loans that will ultimately be held by bondholders backing them must be assembled and graded by dedicated analysts-- FITCH, MOODY'S and BLOOMBERG are the three major clearing-houses for determining relative strengths and weaknesses of any given package, whether or not to recommend a premium or sanction be placed upon any particular series of bonds, and why.
fannie mae/freddie mac bonds offer better yields than do treasury notes, and for as long as they have been around, they've been considered just as safe as it gets for parking huge amounts of cash. time to use their big U word now-- Unfortunately, something has changed.
it started in 1996, and by the time i got into my last real estate project in 1999, all traditional fannie mae/freddie mac underwriting methods were abandoned, in favor of computer programs written by a company called "Fair,Isaac."
again leaving judgement aside, here's how fannie mae and freddie mac underwriting policies have changed:
an applicant applies for a mortgage. this entails providing name, address, and social number to the loan officer. within a few minutes, FICO software generates a numerical borrower score. this makes the final determination as to whether or not the applicant qualifies for a fannie mae/freddie mac loan product, and if so, the terms and conditions they will be offered. making use of bondholders' funds, the program is pre-authorized to print out commitment letters quite literally "on-the-spot." from here, all that is required is the borrower's downpayment and satisfactory property appraisal. no banker or underwriter ever sees the borrower's profile, and the software doesn't consider equity or down payment. methods used to generate these numerical scores are kept secret under government sanction; until recently, scores themselves were shielded behind the corporate veil. this is what FICO means to the consumer. most people don't get to know anything about it until it short-circuits their financial lives. let's now address it from a few other points of view.
lender:-- in the world of fannie mae and freddie mac, this terms means "intermediary," or mortgage underwriter. somebody applies for home financing. plug in name, address, social security number(s). the computer will dictate approval or denial-- if approved, the mysterious software generating that credit score will tell you what interest rate you can offer, and what terms and conditions will be.
bond analyst: after the loan has been written and sold, it's your turn to grade it, all others like it, and determine where to place it. instead of a banker's opinion, all you know now is a numerical FICO score. whatever went into creating the score has been kept secret-- remember, authors of this software won't get rich if people know about it, so don't ask. think of it like the SAT tests you endured on the way to college, and make your best machanical evaluation-- **.
investors: fannie and freddie bought into robotic underwriting, so forget about your money. unknown software is keeping things safe and sound. nobody has been allowed to know how it works, so it must be right, right? worry about it when your staff tells you it's time to file bankruptcy--**
FACT:-- FICO NOW CONTROLS EVERY ASPECT OF FANNIE MAE/FREDDIE MAC MORTGAGE UNDERWRITING-- approval, denial, terms and conditions, interest rate, bond analysis and placement, secondary market investor guidelines.
FACT:-- "LENDERS" OFFERING FANNIE MAE/FREDDIE MAC LOAN PRODUCTS ARE NOT LENDING THEIR OWN MONEY AND THEREBY DO NOT MAKE THEIR OWN LENDING DECISIONS--
when it's their own money out there, they realize they might be sitting on a note for all eternity, and charge accordingly. this is a portfolio loan.
FACT:-- THERE IS NO LONGER ANY HUMAN LINK IN THE CHAIN OF FANNIE MAE & FREDDIE MAC UNDERWRITING--
apart from the initial interview and appraisal of subject property, it's done entirely by computer. say Hi and sign papers with the closing attorney.
that's how it works. i'll be happy to elaborate further if anybody doesn't understand or has any questions.
goodnight-- * |
