Module 2: Desktop Underwriter (DU) Basics

Fannie Mae’s underwriting policies include an evaluation of the borrower’s (or spouse’s, to the extent required by applicable law) equity investment, credit history, liquid reserves, reliable and recurring income, and the cumulative effect that these and other risk factors have on mortgage loan performance. Fannie Mae’s underwriting policies enable the lender to consider various scenarios in evaluating a borrower’s willingness and capacity to repay the mortgage loan. The lender must confirm that information provided by the borrower during the loan application process is accurate and complete; include documentation in the loan file that supports the lender’s assessment of the borrower’s credit history, employment and income, assets, and other financial information used for qualifying; conduct a comprehensive risk assessment of each mortgage loan application; and render a decision to either approve or decline the mortgage loan application.

Fannie Mae offers lenders two options for conducting a comprehensive risk assessment–automated underwriting through DU or manual underwriting. Both methods include an evaluation of the borrower’s equity investment, credit history, liquid reserves, reliable and recurring income, and the cumulative effect that these and other risk factors have on mortgage loan performance.

Desktop Underwriter does an analysis of the loan data. It looks at a very specific set of data. An underwriter will use DU for assistance when evaluating the risk and when making the credit decision on a loan. There are many things an underwriter sees that DU never sees. The only one who can make a credit decision on a loan is the underwriter. DU makes a recommendation.

Before making a credit decision, the lender must look at the probability of the borrower making timely payments and that the lender won’t have to execute the collateral agreement and take the house back. The lender wants to make sure that not only everything that has been seen by the AUS, but everything in the file to make the credit decision, is accurate and is supported by documents.

If the data was transferred successfully and DU was able to make a recommendation, you will have a DU Findings Report. DU needs some type of credit reference. If a tri-merged credit report has already been generated, it can be re-issued.

If there is a loan in the pipeline that was submitted to a previous version of DU, it typically stays in that version until the loan closes. If the loan has been in the pipeline long enough for the version to be retired, the next time the loan is resubmitted it will have to have a new set and new review based on the most updated version of DU.

Credit History

A borrower’s credit history is an account of how well the borrower has handled credit, both now and in the past. An older, established history—even though the accounts may have zero balances—will have a more positive impact on the borrower’s credit profile than newly established accounts.

A borrower who has a relatively new credit history (a few recently opened accounts) is not automatically considered a high credit risk. Successfully managing newly established accounts, including making payments as agreed, signifies lower risk.

Risk Factors

DU considers the following characteristics in the credit report to assess the creditworthiness of borrowers who have traditional credit histories: credit history, delinquent accounts, instalment accounts, revolving credit utilization, public records, foreclosures, collection accounts, and inquiries.

The non-credit risk factors evaluated by DU include: the borrower’s equity and LTV ratio, liquid reserves, loan purpose, loan term, loan amortization type, occupancy type, debt-to-income ratio, housing expense ratio, property type, co-borrowers, and variable income.

DU performs a comprehensive evaluation of these factors, weighing each factor based on the amount of risk it represents and its importance to the recommendation. DU analyses the results of this evaluation along with the evaluation of the borrower’s credit profile to arrive at the underwriting recommendation for the loan casefile.

Delinquent Accounts

Payment history is a significant factor in the evaluation of the borrower’s credit. DU considers the severity of the delinquencies (30, 60, 90, or more days late), the length of time since the delinquencies, and the number and type of accounts that were not paid as agreed.

A payment history that includes bills that are 30 days or more past-due, or a history of paying bills late as evidenced by several accounts with late payments, will have a negative impact on the borrower’s credit profile. The amount of time that has elapsed since an account was delinquent is an important factor included in the evaluation of the payment history. For example, a 30-day late payment that is less than three months old indicates a higher risk than a 30-day late payment that occurred several years ago.

Instalment Loans

DU evaluates how well a borrower manages debt for all types of instalment loans such as mortgage, auto, unsecured, and student loans. Research has shown that borrowers with no active instalment accounts represent a higher risk than borrowers who have active instalment accounts.

Rent Payment History

For certain first-time homebuyers who have a credit score, the lender may use a 12-month third-party asset verification report to have their rent payment history considered in DU. When DU logic can identify rent payments in the asset verification report, it will use the rent payment history to positively supplement the credit risk assessment.

The following requirements apply when using rent payment history in DU:

• At least one borrower must

  • be a first-time homebuyer purchasing a principal residence,

  • have a credit score (nontraditional credit is not permitted), and

  • have been renting for at least 12 months with a monthly rent payment of at least $300.

• For DU to be able to identify rent payments, the lender must

  • enter the monthly rent paid by the borrower in the online loan application,

  • obtain an asset verification report with 12 months of bank statement data through an authorized DU validation service asset verification report vendor, and

  • confirm the borrower is an account holder and that the account provided in the asset verification report is the one from which the borrower pays rent.

• At the time of loan origination, the originating lender must have access to the full asset verification report containing the data covering the period of time provided to DU for assessment.

When an asset verification report is used for both rent history and asset documentation, including asset validation through the DU validation service, only the most recent 60 days of account activity must be reviewed in accordance with the requirements in B3-4.2-02, Depository Accounts and B3-2-02, DU Validation Service, and retained in the loan file. For additional details on record retention, see A2-4.1-01, Establishing Loan Files.

Revolving Credit Utilization

The establishment, use, and amount of revolving credit a borrower has available are important. Trended credit data is used to evaluate the borrower’s ability to manage revolving accounts. A borrower who uses revolving accounts conservatively, meaning low revolving credit utilization or regular payoff of revolving balance, is considered lower risk. A borrower whose revolving credit utilization is high or who has low available revolving credit is considered higher risk.

Public Records, Foreclosures, and Collection Accounts

A credit history that includes any significant derogatory credit event is considered high risk. Significant derogatory credit events include bankruptcy filings, foreclosures, deeds-in-lieu of foreclosure, pre-foreclosure sales, mortgage charge-offs, or accounts that have been turned over to a collection agency.

The more recent such events occurred, the more adverse the impact is on the credit profile. Although most public record information is retained in the credit history for seven years (ten years for bankruptcies), as time passes, it does become less significant to DU’s credit evaluation.

Note: Collection accounts reported as medical collections are not used in the DU risk assessment.

Inquiries

DU evaluates inquiries made within the most recent 12 months of the credit report date. Research has shown that a high number of inquiries can indicate a higher degree of risk. However, multiple inquiries made by different mortgage lenders or different auto loan creditors within the same time frame is not viewed by DU as multiple inquiries (these types of inquiries generally reflect borrowers shopping for favourable rates or terms). A borrower who has frequently applied for, or obtained, new or additional credit represents a higher risk.

Borrower’s Equity and LTV Ratio

The amount of equity in the property is a very important component of the risk analysis. Research has shown that a borrower who makes a large down payment or who has considerable equity in their property is less likely to become delinquent on a mortgage loan than a borrower who makes a small down payment or has a small amount of equity in the property. In other words, the more equity a borrower has in the property, the lower the risk associated with the borrower’s mortgage loan.

DU may use a low LTV ratio to offset other risks that it may identify in the loan application.

Liquid Reserves

Liquid reserves are those financial assets that are available to a borrower after a loan closes. Reserves are calculated as the total amount of liquid assets remaining after the loan transaction closes divided by the qualifying payment amount.

DU considers higher amounts of liquid reserves as more favourable than lower amounts or no reserves. Research has shown that mortgages to borrowers with higher amounts of liquid reserves tend to have lower delinquency rates. As with a low LTV ratio, DU may consider high amounts of reserves as an offset for other risks that it may identify in the loan application.

Loan Purpose

There is a certain level of risk associated with every transaction, whether it is a purchase or a refinance. Purchase transactions represent less risk than refinance transactions. When evaluating refinance transactions, a limited cash-out refinance transaction represents less risk than a cash-out refinance transaction.

Loan Term

Research has shown that mortgages to borrowers who choose to finance their mortgages over shorter terms and build up equity in their properties faster generally tend to perform better than mortgages with longer amortization periods.

Loan Amortization Type

Research has shown that there is a difference in loan performance based on the manner in which the mortgage amortizes. Fixed-rate mortgages will be viewed as representing less risk than adjustable-rate mortgages.

Occupancy Type

Performance statistics on investor loans are notably worse than those of owner-occupied or second home loans. Owner-occupied transactions represent the least risk, followed by second home transactions, and investment property transactions having the highest risk level.

Debt-to-Income Ratio

In DU’s evaluation, generally, the lower the borrower’s debt-to-income ratio (DTI ratio), the lower the associated risk. As the ratio increases, the level of risk also tends to increase; and a high ratio will have the greatest adverse impact on the recommendation when there are also other high-risk factors present.

The composition of the borrower’s debt is also taken into consideration. Borrowers whose revolving debt makes up a smaller percentage of their monthly expense have been shown to represent less risk than those whose revolving debt makes up a large percentage of their monthly expenses. Also, borrowers with student loan debt have been shown to represent less risk than those with only revolving debt.

Housing Expense Ratio

Borrowers with lower housing expense ratios are considered lower risk, while those with higher housing expense ratios are considered higher risk. Research has shown that borrowers whose total monthly expenses are composed primarily of their housing expense may find it more difficult to pay this expense when experiencing an event that would cause financial distress, such as the loss of a job.

Property Type

Another important factor that DU considers in the risk analysis is the collateral or property type. DU differentiates the risk based on the number of units, and in some cases the property type (e.g., manufactured home).

The level of risk associated with each property type is as follows, starting with those property types representing the least amount of risk:

• one-unit properties;

• condo and co-op properties;

• two-, three-, and four-unit properties;

• manufactured homes.

Co-borrowers

DU considers the number of borrowers (who have traditional credit) on a mortgage application in its evaluation because, generally, the presence of more than one borrower helps to reduce risk. Research has shown that mortgages that have more than one borrower tend to have a lower delinquency rate than mortgages with one borrower. However, additional borrowers tend to reduce risk only when they have good credit histories.

Variable Income

DU evaluates the composition of borrower income. As variable income (bonus, overtime, commission, and other income) can differ from year-to-year, borrowers whose total annual income is made up of a higher percentage of variable income represents an increase in risk. Note that other income is based on entry in Form 1003 of “Other” gross monthly income type in current employment, and “Other” in income from other sources.

Risk Factors for Loan Casefiles Where No Borrower Has a Credit Score

DU will consider the following factors when evaluating the overall credit risk of a loan casefile when no borrower has a credit score:

• borrower’s equity and LTV ratio,

• liquid reserves,

• debt-to-income ratio, and

• property type.

See B3-5.4-01, Eligibility Requirements for Loans with Nontraditional Credit, and B3-5.4-02, Number and Types of Nontraditional Credit References, for additional requirements that apply to loan casefiles without credit scores.

Note: If a loan casefile does not receive an Approve recommendation or if the borrower is unable to meet the DU requirements related to the nontraditional credit references required, the lender may manually underwrite and document the loan according to the nontraditional credit guidelines described in this Guide.

Cash Flow Assessment for Loan Casefiles Where No Borrower Has a Credit Score

For certain loan casefiles where no borrower has a credit score, DU can conduct a cash flow assessment when the lender provides a 12-month third-party asset verification report for the borrower. DU will assess the borrower's cash flow management history to determine whether it can be used to positively supplement the credit risk assessment.

To be eligible for the cash flow assessment in DU

• The lender must obtain an asset verification report with 12 months of bank data through an authorized DU validation service asset verification report vendor and confirm the borrower is an account holder.

• At the time of loan origination, the originating lender must have access to the full asset verification report containing the data covering the timeframe provided to DU for the cash flow assessment.

When DU conducts a cash flow assessment and provides an Approve/Eligible recommendation, the 12-month asset verification report may be used to satisfy the nontraditional credit history requirements for all borrowers as outlined in B3-5.4-03, Documentation and Assessment of a Nontraditional Credit History.

When an asset verification report is used for both the cash flow assessment and asset documentation, including asset validation through the DU validation service, only the most recent 30 or 60 days of account activity must be reviewed in accordance with the requirements in B3-4.2-02, Depository Accounts, and B3-2-02, DU Validation Service, and retained in the loan file. For additional details on record retention, see A2-4.1-01, Establishing Loan Files.

Note: If a 12-month asset verification report is not obtained, at least two nontraditional credit references are required for each borrower. See B3-5.4-01, Eligibility Requirements for Loans with Nontraditional Credit.

Analysing Reports

The DU Underwriting Findings report summarizes the overall underwriting recommendation and eligibility component of the loan casefile and lists certain steps necessary for the lender to complete the processing of the loan file.

Specific messages are provided for each individual loan casefile. These detailed messages are designed to assist lenders in processing and closing loans. However, the level of documentation recommended by DU may not be adequate for every borrower and every situation.

The DU Underwriting Findings report is divided into sections. Each section contains a different type of message. Certain messages will be provided based on the DU credit risk assessment. For example, some messages are returned only on Approve recommendations, while other messages are returned only on Refer with Caution recommendations.

• Summary: Contains “DU” Recommendation and Purchase Eligibility

• Day 1 Certainty Messages: Day 1 certainty or Enforcement relief on property value)

• Risk and Eligibility: Provides details on risk recommendation and why loan is NOT eligible for delivery and possible data entry errors

• Findings Section: Indicates strengths in the file/loan application

• Verification Message/Approval Conditions Message: Contains minimum DU requirements for documentation and potential red flag messages

• Observations Section: Contains “FYI” for you and your lender

• Underwriting Analysis Report: Modern 1008/Summary of the transaction

• Lender Guidance for Use with Applicants: Will appear only on Refer/w Caution Recommendation

Day 1 Certainty

Day 1 Certainty for data validation is the confidence that Fannie Mae will not enforce certain representation and warranty obligations for loan components that have been validated by the DU validation service.

With Day 1 Certainty, if your income, employment, and asset information are validated against approved third-party vendors, no further validation or documentation is required. This provides a seamless, simple process for our clients.

Specifically, when DU has validated one or more loan components, Fannie Mae will not enforce representations and warranties for:

• Income calculation – the calculation of the income amount used to qualify the borrower when that income is able to be validated by the DU validation service (per borrower, per income-type)

• Employment status at closing – the borrower’s employment, through the time of closing, that the employer attested to on the loan application (per borrower, per employer)

• Asset calculation – the accuracy of the amount of assets relied upon to satisfy the total amount of assets required to be verified by DU (loan-level)

• The integrity of the data provided on the eligible report obtained from the report vendor

DU Recommendations

• Approve: Indicates the loan satisfies Fannie Mae’s credit risk standards.

• Eligible: Indicates the loan satisfies Fannie Mae’s loan eligibility criteria.

• Refer/Eligible: Indicates the loan is eligible for manual underwriting but must be underwritten by a certified underwriter to address the “refer” reason.

• Ineligible: Indicates the loan does not satisfy the Fannie Mae’s loan eligibility criteria.

• Refer w/Caution: Indicates the loan does not meet credit risk or loan eligibility standards and is ineligible for delivery to Fannie Mae.

• Out of Scope: Indicates DU is unable to underwrite the loan file as submitted.

General Lender Requirements

When underwriting loans with DU, the lender must:

• employ prudent underwriting judgment in assessing whether a loan casefile should be approved and delivered to Fannie Mae;

• confirm the accuracy of the data it submits, making sure that it did not fail to submit any data that might have affected the DU recommendation had it been known;

• ensure that the loan complies with all the verification messages and approval conditions specified in the DU Underwriting Findings report;

• apply due diligence when reviewing the documentation in the loan file;

• review the credit report to confirm that the data that DU evaluated with respect to the borrower’s credit history was accurate and complete;

• determine if there is any potentially derogatory or contradictory information that is not part of the data analysed by DU; and

• act when erroneous data in the credit report or contradictory or derogatory information in the loan file would justify additional investigation or would provide grounds for a decision that is different from the recommendation that DU delivered.

For example, if a foreclosure was reported in the credit report but was not detected by DU (that is, it was not referenced in any verification messages), the lender must determine if the loan complies with the applicable guidelines (see B3-5.3-07, Significant Derogatory Credit Events — Waiting Periods and Re-establishing Credit).

See the Desktop Underwriter & Desktop Originator Learning Centre for a number of helpful resources.

Lenders are responsible for integrity of the data submitted to DU.

• Do you have all pages to the bank statement and are all large deposits addressed and sourced?

• Retirement accounts? Access verified if required? Fully vested? Did you subtract any outstanding loans and is applicant fully vested?

• Truncated account numbers allowed as long as the last four digits are displayed

• Paying off a second mortgage? Verify it was used to purchase the property or treat the loan as a cash out. Also verify seasoning requirements for ownership and taking cash out.

• Refinance: Is the property currently offered for sale or has it been offered for sale in the past six months? For refinance transactions, properties must have been taken off the market as of loan disbursement date.

• Is Property type entered correctly (condo, PUD, manufactured home)

• Are the HOA dues, flood insurance or MI payments included in the housing payment, if applicable? Do you have written support?

• Does the occupancy make sense? Are the “Potential Red Flags” cleared as per the DU findings report?

• Are all the assets per DU verified plus any additional that are needed to pay off a judgment or collection? Evidence of liquidation if needed? Additional reserves?

• Deferred loans must always be included in the debt ratio; Use amount on credit report, 1% of unpaid balance or actual verified payment

• Student loans in repayment use actual payment per credit report or student loan documentation; Payment may be zero if verified and IBR plan and the payment is zero.

• Lease Payments must always be included in the debit ratio regardless of number of payments remaining

• Instalment/lease debt without a payment on the credit report, you must obtain documentation to verify the actual monthly payment amount (Exception: Deferred Student loans see Selling Guide)

• Include revolving debt unless being paid off prior to or at closing; A payment may still be used based on underwriter judgment

• Income: Break it out by type, check trends, history of receipt

• Do names, addresses and social security numbers match from document to document?

• Tax Liens may be included as a debt instead of having to pay off, see guidelines to be able to include as a payment

• Lenders required to choose the most reliable appraisal when two appraisals are obtained

• Waiver of project reviews for all detached condo units (excluding manufactured homes) and allow use of C-TP financing for detached condo units

• HomeStyle Renovation eligibility allows LTV up to 97% for 1-unit primary homes

• Anything entered in these new fields, the casefile will be underwritten as a HomeStyle Energy Mortgage

  • Energy Improvement Amount

  • PACE Loan Payoff Amount

• Allow lenders to underwrite loans (either with DU or through manual underwriting) for borrowers who have frozen credit at only one of the three national credit repositories.

• Native American tribes and their instrumentalities as eligible providers for Community Second Mortgages

• DU casefile or the Doc File ID may not be used more than once, and a new error message will appear if a lender attempts to do so

• DU loan casefile archival policy is extended from 270 days (9 months) to 28 months and DU will now use the date the casefile file was last submitted to determine archival date

• Fannie Mae does allow loans to be closed in the name of a trust

• To exclude a liability that someone else pays requires documentation for 12 months showing timely payment and to exclude a mortgage, they must be a co-signer

• When excluding a mortgage payment that someone else has been verified making the payments, it is the PITIA that can be excluded as long as no rental income is being used from that property; Note that the property MUST be included in the borrower’s multiple financed property count & the UPB for the mortgage must be included in the calculation of reserves for multiple financed properties

• Premium pricing (which is a when a borrower selects a higher interest rate in exchange for a lender credit) cannot be used for any portion of the down payment or reserves and should not exceed the closing costs.

• Lender credits derived from premium pricing is not considered an IPC even if the lender is an interested party to the transaction

• An appraisal waiver is not eligible for investment properties if you are using rental income from the subject property

• Appraisal waiver is not eligible if an appraisal has been uploaded through the Uniform Collateral Data Portal (UCDP)

• Civil judgements will NOT appear on the credit report due to implementation of the National Consumer Assistance Plan in 2017; Fannie Mae policy did not change. The Selling guide defines lender responsibilities and requirements for payoff of liens, judgments, and undisclosed liabilities