Why Haven’t Loan Officers Been Told These Facts?

FNMA/FHLMC COVID Updates, Underwriting the Self Employed Just Got a Whole Lot Easier

Another Reason for Early Tax Filing

Last week the Journal described how the GSEs have been tough on self-employed applicants. Consequently, lenders have found underwriting the self-employed particularly challenging during the COVID era.

If you’ve wondered why it’s been such a pain in the rear to get self-employed loans done, it boils down to one word, risk – chiefly underwriting and warranty risk. Furthermore, there is a risk of ATR noncompliance.

The GSEs ask, “is the applicant’s business plan adequate to navigate the pandemic effects?” Heck – that’s what big companies pay high-priced consultants to figure out. Unfortunately, the implied requirements for business analysis and the lenders’ overreliance on the P & L makes the ensuing credit decisions far too easy for FNMA to second guess.

Suppose FNMA audits the loan and identifies a significant origination defect surrounding income. In that case, considering the ambiguity of the underwriting criteria, lenders have little defense against a repurchase demand or similar remediation.

If FNMA subjectively determines the lender failed to follow the underwriting guidelines, that is the end of the story. In a word, ambiguity. That is why a lack of specificity in the guidelines presents uncertainty for the seller. At present, the ambiguity of the temporary COVID rules is the primary reason why self-employed loans have been a more considerable pain than in pre-COVID times.

Now the good news. As mentioned last week, if the applicants have filed their 2021 return, sellers may essentially return to the standard Selling Guide policies for the self-employed. That dramatically reduces the emphasis on the P & L and eases the necessity for overly subjective underwriting analysis.

Loan officers must appreciate the concept of risk to anticipate the loan manufacture better. Risk in this context is another word for uncertainty. Business income tends to be more dynamic compared to employment income. Therefore, the business income analysis tends to revolve around how the net profits change from period to period.

Fast forward to the novel pandemic variable. As a result of the COVID impacts on income stability, COVID represents a new and unstable element to consider in the self-employment matrix. That equates to risk.

The pre-pandemic documentation and underwriting guidelines no longer afford the analysis required to mitigate loan and portfolio level risks commensurate with the self-employed income.

Bear in mind that an unaudited profit and loss statement is a relatively meaningless risk response. Instead, an overreliance on unaudited P & Ls turns the dial towards the pre-Dodd-Frank use of stated income. An audited profit and loss could be much better. While true, audit quality varies, at least there is a semblance of a reliable third-party record used in the capacity analysis.

Another problem with the P & L analysis is that FNMA requires a P & L but makes the balance sheet optional. And for some businesses, a cash flow statement is another window into business health. Using a P & L without at least the balance sheet is like assessing acceptable closing assets based on current bank balances alone. The P & L by itself leaves critical data out of the equation. Using unaudited income statements is really a return to stated income (which, practiced selectively, is not a bad idea in this editor’s opinion).

Regardless of the audit standards, another issue is asking underwriters to make assessments beyond their training or expertise. The greater the subjectivity in the analysis, the greater the threat risks to the lender.

Think this through. Suppose the underwriter evaluates a loan scheduled to close in July 2022 and relies on a 2019 and 2020 tax return with an 18 month P & L, ending June 2022. Would anyone suggest the lender use an 18 month unaudited P & L for purposes of TILA ATR compliance? Okay, so we might get a few bank statements. But bank statements may or may not verify anything relevant.

The GSEs talk out of both sides of the mouth. Don’t use the P & L for income calculation. Use the P & L to confirm stability. What’s the difference? If the underwriter uses the 2019 and 2020 returns to run the income analysis and then uses the P & L to confirm that the income hasn’t declined – how is that not using the P & L to calculate income?

Is an unaudited P & L a reliable third-party record? No. Of course, the ATR requirements apply to the self-employed too. So the self-employed concerns are manifold. Watch your P & L’s. If you are not using a 2021 return, think carefully. Before the lender declines the submission with the unaudited P & L, the LO could strongly suggest audited statements and ensure that the prospect is up to speed on Non-QM alternatives. Better yet, now is an excellent time to encourage prospects to get off their buts and get their 2021 returns completed.

Depending on the transaction, an audit is probably a less expensive alternative to a Non-QM solution. However, audits are a big deal. Furthermore, March and April are not good times to ask accountants to conduct an audit. Audits make the loan manufacture look like a cakewalk.

Keep in mind, if the lender isn’t comfortable interpreting the statements and otherwise adhering to the nebulous GSE business analysis “suggestions,” be forewarned. You may have an uphill slog with the capacity test. Know thy lender and the lenders’ risk appetite for the product.

The Journal continues to explore the self-employment challenges next week.

Fannie Mae LL-2021-03 Page 1 of 6
Lender Letter (LL-2021-03) Updated: Feb.2,2022
To: All Fannie Mae Single-Family Sellers
Impact of COVID-19 on Originations
COVID Updates, Feb. 2, FNMA Lender Letter here:


Behind the Scenes
Non-QM Lending, Will it Take Off This Time? The Stars Are Aligning.

With the rise of self-employed workers, it stands to reason that lenders scrambling to replace the refinance volume might focus on providing conduits for these folks. However, a recent Federal Housing Finance Agency (FHFA) report suggests that underwriting may tighten simultaneously with a surge of the self-employed. As a result, the market may see an exponential growth of underserved self-employed home buyers. That would appear to present an opportunity for non-agency lending and in particular, Non-QM lending.

The COVID environment has been an unforgiving one for self-employed mortgage applicants. The GSEs may find themselves a dollar short once more as agile market participants eye current and developing underserved market segments. Notably, because of the risks inherent with self-employed borrowers, the GSEs apparently choose to pass on making the accommodations necessary to serve this segment better. It stands to reason that now is the time for a revitalized Non-QM market.

From the FHFA (See the graphic at the top of the article)

“The graph shows that, following the housing bust in 2007, lenders tightened underwriting standards considerably for a number of years. The underwriting standards in 2020, as indicated by this variable, are almost as tight as those during the 2007–2009 period. Moody’s forecasts that underwriting standards will be relatively less tight for 2021 and 2022. Underwriting standards are forecast to tighten again in 2023 and 2024, although they will not be as tight as the conditions in 2020.”

From JP Morgan Asset Management (The investor side)

“Today’s non-QM borrowers typically have credit scores between 700 and 750, as well as documented income, assets and equity in their homes. So it seems to me that we are talking about loans extended to a sliver of the US population that is considered just below “prime” and, additionally, has the compounded misfortune of possessing some other quality frowned upon by Fannie or Freddie. The most common offense, it turns out, is that they derive income from non-W2 sources. In many deals, over 50% of loans are made to self-employed borrowers. And, by the way, knowing that these unfortunate members of the gig economy have nowhere else to turn, lenders are charging 200-300 bps higher than the conforming mortgage rate.”

“Of course, as investors, we are naturally skeptical and as fixed income investors we are scared of our own shadows. So, as a result, we are carefully watching the underwriting trends in these deals for signs of any worrisome deterioration. We meet with all issuers and try to discern between those who are in it for just the juicy mortgage rates they can charge today, versus those who aspire to be in the mortgage business longer term. We are optimistic about the growth in this space and have thus far been successful in finding relative value opportunities.

“And on that note, please indulge me with one more number: Zero. That’s the total amount of losses ever incurred by non-QM bondholders to date.” – Dhruv Mohindra, JP Morgan

Have the Stars Aligned? Non-QM is Not Your Father’s Subprime Loan

Arguably, the stars have aligned. Today’s Non-QM is nothing like the junk subprime loans of the past. Today, Non-QM loans are more like the first iterations of limited documentation products in the early 1980s. At that time, lenders offered stated-income to applicants with impeccable qualifications. Typical of those early stated-income products, 25% down, near-perfect credit, and the ability to evidence acceptable closing funds. There were relatively few performance issues with those loans compared to similar loans with full doc manufacture.

Thrifts like Ahmanson and Great Western seasoned these non-agency loans before going to market, similar to the new Seasoned QM requirement. That is the kind of innovation and subprime product the financial market needs today. The Seasoned QM rules are a step in the right direction. A return to sound and innovative non-agency solutions is essential to the all-around health of the markets.

The ATR standards are broad. That is both good and bad for risk management. However, anticipate that the General and Seasoned QM models should stimulate a broader market for non-agency. This market expansion means more competition, which means better pricing for consumers.

Non-agency loans fit nicely into the General QM model. 225 BPs over APOR is a very reasonable return for high-quality mortgage loans. That means the risk pricing inherent with certain segments of Non-QM should fall. As a result, there should be a growing market for non-agency loans priced between agency and the average Non-QM prices.

The industry could use some fresh terminology for these tweeners. Non-QM is decidedly unsexy. “Preferred” non-agency? Back to the future. A-, B+, and C risk pricing matrices.

Once again, the GSEs may find that their one-size-fits-all aversion to the self-employed puts them at risk of unnecessarily losing market share. And that could be a good thing for consumers.


Tip of the Week – Don’t Piss-Off Your Regulator
What Has Your Regulator So Pissed OFF?

Okay, we have been promising this feature for a few months. So here is our first installment.

Most states have consumer protection laws similar to the protections set forth under federal laws. Furthermore, the principles behind these alleged state violations are pretty standard state consumer protection statutes and regulations. So even though you might not be licensed in the state bringing the enforcement action, the enforcement discussion is relevant for any jurisdiction.

The Journal begins our series with a complaint stemming from an advertisement by the business licensee. The allegations could lead one to surmise that the regulator believed the Complainee was using the age-old marketing technique of making them sick then offering a cure. If the disclosure (communication) is clear and truthful, there is nothing wrong with that approach.

However, why bother with deceptive come-ons when the facts of the matter offered a compelling reason to consider refinancing? The Complainee should consider themselves fortunate that it wasn’t the FTC or CFPB getting wind of this nonsense. Those guys don’t get out of bed in the morning for $25,000.

The legal stuff is dry, but it’s worth a read. See if this order sounds familiar. Maybe a little MAP Act with a hint of UDAAP? Courtesy of our friends at the Massachusetts Division of Banks (DOB).

Statement of Facts (Abridged and redacted) From the DOB

“On or about November 10, 2021, the Division was forwarded a copy of a solicitation received by at least one Massachusetts consumer from (Complainee).

The “Adverse Market Refinance Fee” was a fee charged by Fannie Mae and Freddie Mac to consumers who refinanced their non-exempt, conforming mortgages between December 1, 2020 and August 1, 2021. It was a one-time fee paid as a part of the refinance.

The solicitation references a “Notice of Fee Removal” with the current month and year above the current lender of the consumer. On the opposite side from the current lender information, the solicitation provides a notice date of November 4, 2021, a notice number, the “proposed lender” (Complainee) along with the NMLS number of (Complainee).

The body of the solicitation notified the consumer that the loan with the consumer’s current lender has been identified as benefitting from the removal of the “Adverse Market Fee.” The solicitation continued to state, “The removal of this fee will generate economic benefits for those, like you, with a conventional mortgage.”

This statement is misleading as the removal of the fee would only affect a consumer if they were to refinance their mortgage. Also, unless they had refinanced between December 1, 2020 and August 1, 2021, the consumer had never paid the fee.

Under the heading “What You Need to Do” (emphasis original) the solicitation instructs the consumer to provide the notice number information to the “Fee Removal Help Desk” (LOL!!! – emphasis added) in order “to get the necessary information”.

The solicitation misleadingly implies that the consumer’s account already includes the “Adverse Market Fee” and that the consumer would need to take active steps in order to have the fee removed.

The language and references in the notice collectively create the appearance that the consumer automatically qualified for a lower monthly payment and failed to explain or describe the “Adverse Market Fee” in the appropriate context.

Although the bottom of the solicitation identified that this was a third-party offer for a refinance program, not everyone who received the letter would qualify for the program; furthermore, eligibility must be confirmed in order to receive a lower payment and interest rate, but such language was in a font size that is significantly smaller than that of the body of the solicitation and is located in a non-prominent location at the bottom of the solicitation.


“Defendant has submitted payment of twenty-five thousand dollars ($25,000.00) in satisfaction of an administrative penalty.

WHEREAS, M.G.L. chapter 93A, section 2(a) states, “Unfair methods of competition and unfair or deceptive acts or practices in the conduct of any trade or commerce are hereby declared unlawful.”

WHEREAS, regulation 940 Code of Massachusetts Regulations (C.M.R.) 8.06(1) states, “It is an unfair or deceptive act or practice for a mortgage broker or lender to make any representation or statement of fact in an advertisement if the representation or statement is false or misleading or has the tendency or capacity to be misleading, or if the mortgage broker or lender does not have sufficient information upon which a reasonable belief in the truth of the representation or statement could be based.”;

WHEREAS, regulation 209 C.M.R. 42.12A(9) states, “It is a prohibited act or practice for a mortgage broker or mortgage lender to make false promises to influence, persuade, or induce a consumer to a sign a mortgage loan application or mortgage loan documents.

WHEREAS, pursuant to M.G.L. chapter 255E, section (7)(b) and M.G.L. chapter 255E, section 11, the Commissioner issued a Temporary Order to Cease and Desist and Notice of Administrative Penalty (“Order”), against Defendant on January 4, 2022, based upon information reflected in a solicitation (“Solicitation”) sent by Defendant to Massachusetts consumers.