What has the housing crisis got to do with credit? EVERYTHING!
By Pam Marron
We knew what the mortgage criteria was after a foreclosure and a bankruptcy. Now we had new mortgage criteria for a short sale.
Short sales were different than a foreclosure. To be approved for a short sale the homeowner had to have negative equity, where more money was owed on the mortgage than the home was worth, and hardship had to be proven. A little known fact at the time was that in order to get a short sale approval, lender loss mitigation policy required mortgage delinquency first. This was not reported in the press and instead short sellers were en-masse labeled as “strategic defaulters”, or those who could make the payment but chose not to.
Unknown to all who went through the lengthy short sale process was that once their mortgage delinquency went past 120 days, mortgage credit was coded as a foreclosure. Past short sellers were unaware of this until they reapplied for a new mortgage years later. The credit code for short sales turned out to be borrowed Metro 2 credit code from foreclosures… and for conventional mortgages, resulted in the same seven year wait applied to past foreclosures, rather than the two year wait required after a short sale.
And, let’s be clear. Yes, there were those who were taking advantage of a backed up system. These were the stories we saw in the press. But in August 2013, a paper came out from the Federal Reserve Bank of Atlanta that suggested that “ruthless” or “strategic” default during the 2007–09 recession was relatively rare.
As a mortgage broker for the last 30+ years, if there is one thing that is constant, it is that credit has EVERYTHING to do with getting a mortgage. Credit sets the bar for the interest rate, the loan to value, and is the ultimate factor between being approved or not. Getting credit errors fixed has permanently attached each of us in this industry to our preferred credit reporting agencies who work on borrower credit when errors exist.
The amount of credit error our industry has had to deal with during this housing recession has been incredibly high, with widespread problems ranging from short sales coded as a foreclosure to invisible mortgage history when mortgages included are not re-affirmed. Hardest Hit states with high number of short sales and foreclosures saw it the most. And consumers trying to fix problems by disputing errors still end up with a denial or stall until the dispute is taken off. Most often, additional cost to fix apply but helpful credit reporting agencies have done all they can to provide avenues for consumers to fix credit themselves.
WHY credit errors became so important
As a mortgage broker in Florida, a state at the top of the Hardest Hit list during this recession, my goal six years ago was to find all avenues back into housing for the huge number of homeowners in Florida who lost their homes. A short sale had the shortest wait timeframe afterwards back then…. two years with 20% downpayment. At that time, there were over 13 million homeowners still underwater. If this problem did not get fixed millions would be stalled from re-entering the housing market.
Finding VISIBLE credit code error
Little did I or anyone else know that borrowed foreclosure code from Metro 2 was being used for short sale credit. The method of payment (MOP) code “M8” and/or a “5” in the payment history line prompted a denial through both Fannie Mae and Freddie Mac for a conventional mortgage, even though the consumer had a past short sale that was over 2 years old.
Finding this error was like a needle in a haystack. My credit report rep. at Acranet, Renee Erickson, had found it, but it was in back end code that was not on the face of the credit report. And lenders across the U.S. did not know that SOME visible places, like the MOP or a horizontal payment history line, could be added to data on their reports. And even if this was done, drilling down to WHICH REPOSITORY of Experian, TransUnion or Equifax that was coding as a foreclosure had to be done. Oftentimes it was Experian, and they insisted their coding was correct.
Short sale coded as foreclosure first seen in Fannie Mae automated underwriting system (AUS) for conventional loans
The difference was that Fannie Mae’s Desktop Underwriter system showed which mortgage account was causing the denial. Freddie Mac’s Loan Prospector did not show the troublesome account but mentioned “recent foreclosure/signif derog appears on credit report”. This is the only clue through Freddie Mac to this day of which account is causing a denial. This would stall thousands of eligible past homeowners from re-entering the housing market with a conventional mortgage.
FHA and VA mortgages did not have the same denial result because Total Scorecard, a parallel automated system, issues a requirement for validation of no foreclosure, but issues an Approve/Eligible!
National Credit Reporting Association (NCRAinc.org) becomes involved
Because of the mortgage denials that were resulting for past short sellers that were eligible to repurchase a home again, the executive director and board members of the National Consumer Reporting Association stepped in to help. The matter was taken to the Consumer Financial Protection Bureau (CFPB) twice, and they saw the problem. Florida’s U.S. Senator Bill Nelson also became involved and demanded a fix. He saw first hand how this problem was affecting the comeback of Florida, third from the top of Hardest Hit states. The idea to make a specific short sale code gained traction. But, around June 10th, 2013, talk was that the problem was in the Fannie Mae automated system, and that ‘s where efforts to correct focused.
Fannie Mae “Fix” put in place
On August 17, 2013, Fannie Mae announced a “fix” within their automated system after collaborated efforts with the CFPB and Senator Nelson. The “fix” would take place on Nov. 16, 2013.
I had 10 applications ready to test that day and only 2 made it through. Consumers and lenders were furious when the system reacted the same as before. Out of frustration clients and I started submitting complaints on the CFPB website at Submit a Complaint(directions on this site)….. and it worked! Within days of the complaints, lenders were responding to the CFPB with resolve to fix. And they did.
Realization that there was good credit code that could be used
Because lenders were changing coding that could be compared to coding received upon the mortgage denial, there was a way to see the difference. And when automated approvals started happening after consumers got verification back through the CFPB, that comparison was done. What was discovered was Yes, lenders could change code applied initially for a short sale.
WHY short sale credit became the focus
Short sales were a new phenomena of this economic housing crisis. A fact that was kept quiet was that lenders required short sellers to be delinquent on their mortgage in almost every case before they would issue an approval. (VA short sales did not require this.) Additionally, a hardship would commonly be required.
Because mortgage delinquency was required, short sellers were being reported en-masse as “strategic defaulters” even though many did not want to default. I was receiving calls on a daily basis from short sellers across the U.S. who were angry that delinquency was required, fearful of how this would affect them going forward. And upon 3-way calls with these consumers and their lenders, every time…. on recorded calls, lenders would finally state there was nothing that could be done until a mortgage delinquency occurred.
The executive director of the National Consumer Reporting Association and I took this to the U.S. Treasury and the CFPB upon two visits to Washington, D.C. Upon stating what was heard on calls, proof was demanded. I realized this statement hit an angry nerve of many at the highest level of the banking industry.
This is Loss Mitigation Policy for Short Sales. Leave it Alone.
Loss mitigation policy made to handle short sales was supposed to be different from foreclosures. Those with a foreclosure were not usually working with the lender, their excessive mortgage delinquency usually prompted the foreclosure or they did not have an acceptable hardship.
But homeowners that that endured the lengthy process of a short sale thought the end result would be different and better. After all, the published wait timeframe after a short sale was 2 years, different from the wait timeframe of seven years after a foreclosure. Past short sellers were shocked every time a turn down resulted after a two year wait to get a new mortgage. They had no idea their short sale was credit coded as a foreclosure.
It also became clear that requiring the delinquency was a policy decision of lenders, and not required. Initially, the policy was in place as a “dual tracking” mechanism, that would speed up a foreclosure process if the homeowner did not qualify for a short sale.
In Jan. 2014, Dual Tracking was stopped by a CFPB regulation. But, to this date, lenders still require mortgage delinquency, often stated as an “investor requirement.”
“Strategic Default” Label on Most Short Sellers Affects Mortgage Underwriting
As a mortgage broker, I became heavily involved in finding and using mortgage wholesalers who would decision conventional mortgages for past short sellers on an “Approve/Eligible” in the Fannie Mae automated system. However, it became apparent that criteria and documentation required IF there was no turndown or downgrade to a manual (which was almost impossible to get on a conventional mortgage) was great. Because of detail required on these earlier cases, the 3 intensive documents, “Borrowers: How to Make Your Case“, “LO: Economic Event Worksheet” and “LO:Income Reduction/Debt Table” were made to help borrowers and loan originators who desire to help those with a past short sale or a foreclosure re-enter the housing market.
“Extenuating Circumstances” and “Economic Events”
New criteria defines “Extenuating Circumstances” for when a conventional mortgage can be attempted prior to the NEW wait timeframe of 4 years after a short sale. There are also “Economic Events” exceptions for FHA’s “Back to Work” program that allows a new mortgage as early as 1 year after a short sale, foreclosure and bankruptcy.
In sharp contrast to prior studies that proxy for individual unemployment status using regional unemployment rates, we find that individual unemployment is the strongest predictor of default. We find that individual unemployment increases the probability of default by 5–13 percentage points, ceteris paribus, compared with the sample average default rate of 3.9 percent. We also find that only 13.9 percent of defaulters have both negative equity and enough liquid or illiquid assets to make one month’s mortgage payment. This finding suggests that “ruthless” or “strategic” default during the 2007–09 recession was relatively rare and that policies designed to promote employment, such as payroll tax cuts, are most likely to stem defaults in the long run rather than policies that temporarily modify mortgages.