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Is there racial bias baked into GSE underwriting?

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A recent syndicated article on racial bias from The Markup on racial bias, published by ABC news, AP,  Market Watch and more, has drawn a great deal of attention from trade groups, policy makers and housing advocates with support from some and attacks from others.

The story, “The secret bias hidden in mortgage-approval algorithms,” included statements from fair housing activists who concluded that there is “systemic racism” in the mortgage process. But the same story got pushback from the MBA and the ABA, as well as the CHLA, arguing that the data was selective and produced a biased conclusion.

The MBA was clearly agitated by the story to the point that they put out a public statement which sits on their website and was sent out to newslink subscribers stating, in part, “from the beginning, we explained to The Markup that its analysis of HMDA data, and its pre-determined conclusions regarding mortgage lending, fail to take into consideration several key components that form the backbone of lending decisions, including a borrower’s credit score and credit history.”

I also was quoted in the article stating, “This is a relatively new world of automated underwriting engines that by intent may not discriminate but by effect likely do.”

In an effort to unpack this debate and give at least one additional perspective that defends both viewpoints in different ways, let me highlight why I believe that there is a level of racial bias and discrimination in the manner by which the GSEs price and underwrite mortgages, which is likely to push more minority applicants to an FHA mortgage or perhaps end up without a mortgage at all.

First, I take issue with the article for a few reasons. HMDA data shows outcomes across a variety of variables, including race, but does not show FICO information. Obviously to anyone in the business that’s a big deal given that FICO is a threshold data point that determines eligibility for a mortgage.

Second, the reporters looked at conventional loans only, meaning loans only from Fannie Mae and Freddie Mac, and did not include loans from FHA/VA/USDA. This is important as FHA in particular has a much higher mix of successful mortgages to minority borrowers. On these two points alone, the MBA and ABA were on point that the conclusions were skewed because they missed these key points.

The authors argued that the MBA had been one of the organizations working to ban the publication of FICO scores in HMDA reporting, but I agree with the MBA’s reasoning here. With the elements reported to HMDA, should FICO have been included in public reporting, privacy risk would be dramatically heightened. This doesn’t, however, excuse the authors from at least acknowledging why this data element is so important.

Now, with all that said, let me articulate why I believe, as I said in my quote, “This is a relatively new world of automated underwriting engines that by intent may not discriminate but by effect likely do.”

Risk-based pricing

The GSEs risk base price their mortgages while FHA flat prices theirs. The result here is that borrowers who have FICO scores below, say, 720 with a high loan to value (LTV) will often find a better deal by going to the FHA. Where I take issue with the GSEs’ pricing methodology is how they combine loan-level pricing adjustments (LLPA’s) on top of base g-fees for low downpayment borrowers at levels that some have stated seem excessive.

The GSEs have private mortgage insurance to protect their losses down to about a 65% LTV even with a minimal downpayment from the borrower. With private capital protecting losses down to almost catastrophic risk levels in the event of default, why then do they charge such exorbitant premiums on top of that coverage?

For example, on a 95% LTV purchase with a 640 FICO, there is an additional 275 bp fee added on top of the base g-fees and MI expense. The reason this is done is simple, the GSEs believe, as stated in public testimony by FHFA, that the counter-party risk of the MI companies is not sufficient to protect that first loss in a deep recession, as MI companies can fail and might not pay claims.

But in recent years, the GSEs have established new capital requirements on MI companies to protect against a significant event, making me question why they still have not modified the aggressive LLPA structure to account for that deep first-loss coverage. Simply put, many low downpayment borrowers are hit with additional costs from MI and LLPAs that will result in higher rates or perhaps forcing them to FHA. And low downpayment borrowers have higher concentrations of minority applicants thus in part contributing to denial rates.

Credit scoring

The use of credit scores in underwriting took hold in the mid- to late 1990s as a standard for evaluating willingness to repay a debt. FICO is the standard used for this process and while the GSEs argue that they use their own credit scoring methodology in their underwriting systems, the lender still uses FICO to set floors, establish pricing and more.

There are two issues here. First, the GSEs have not updated their AUS models with updated FICO models, let alone the fact that they refuse to even pilot alternative models such as vantage score, which claims to be able to score thousands of more borrowers that today are denied access to credit.

Second, the FICO model does not give value to timely payment of rent, utilities, cell phone bills and other consistent payments made by people that are not captured in a score. While Fannie Mae should be applauded for their recent announcement that they may include rent history in a credit score, that is too recent an announcement to assess the effectiveness.

The challenge here is that underbanked Americans who make timely payments but have no credit, or perhaps less than the multiple lines that produce a high FICO score, will have greater difficulty getting a mortgage. This has a particularly greater impact on Hispanic and African Americans whose scores may be lower simply because their proven history of repayment does not fit into a scoring model.

2 of 3 Rule

In January of this year, just before Mark Calabria left office, the FHFA, Treasury, and the GSEs finalized an amendment to the Preferred Stock Purchase Agreement (PSPA) that did a number of things affecting second homes, 2-4 units, cash sales and more. But in addition, the rule caps purchases from any lender, “to a maximum of 6% of purchase money mortgages and maximum of 3% of refinancing mortgages over the trailing 52-week period can have two or more higher risk characteristics at origination: combined loan-to-value (LTV) greater than 90%; debt-to-income ratio greater than 45%; and FICO (or equivalent credit score) less than 680.”

This rule remains in effect today. This 2 of 3 factor rule will clearly have a greater impact on first-time home buyers and minorities who are more likely to hit at least two of these caps at higher rates than white non-Hispanic borrowers.

Many argue that this is all ok, that the GSEs are quasi private companies and have set standards based on their view of risk and that the FHA, VA, and USDA can help provide options should a borrower not qualify for a conventional mortgage. I am not here to argue either for or against this argument. But none of this changes the outcome. The effect of some of these policies will produce a selection bias in terms of outcomes.

Earlier this year, a publication from the Harvard Joint Center For Housing Studies concluded that Black borrowers get charged higher rates across all income levels. In the research piece they acknowledged that “many other factors affect interest rates including wealth, debt, credit score, downpayment, mortgage amount, and duration.” But the research also concluded that “Black homeowners have experienced systemic barriers to homeownership and wealth-building opportunities that have limited their ability to access credit, which is a key component in receiving low mortgage interest rates.”

When I read the MBA response to the article from The Markup, I thought that this was a classic response from the trade association that represents industry, and in reading their comments I agreed with the concerns that I stated at the onset of this commentary. But I would argue that the gap in homeownership rates by race, credit scoring methodologies and pricing structures should be an area where industry leadership aligns with consumer advocates to argue for change.

When I started my career as a loan officer, there were no credit scores. The philosophy was that no credit wasn’t necessarily bad credit and underwriters could make judgement calls in order to approve a loan. The problem is that the old process resulted in racial bias as well. Technology and scoring takes color out of the decision-making process. But that does not mean that it’s not without flaws. There should be as much effort to calling out these flaws as there is in defending industry from the points made in this story.

David Stevens has held various positions in real estate finance, including serving as senior vice president of single family at Freddie Mac, executive vice president at Wells Fargo Home Mortgage, assistant secretary of Housing and FHA Commissioner, and CEO of the Mortgage Bankers Association.

This column does not necessarily reflect the opinion of HousingWire’s editorial department and its owners.

To contact the author of this story:
Dave Stevens at dave@davidhstevens.com

To contact the editor responsible for this story:
Sarah Wheeler at swheeler@housingwire.com

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Are Sallie Mae Student Loans Federal or Private?

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When you hear the name Sallie Mae, you probably think of student loans. There’s a good reason for that; Sallie Mae has a long history, during which time it has provided both federal and private student loans.

However, as of 2014, all of Sallie Mae’s student loans are private, and its federal loans have been sold to another servicer. Here’s what to know if you have a Sallie Mae loan or are considering taking one out.

What is Sallie Mae?

Sallie Mae is a company that currently offers private student loans. But it has taken a few forms over the years.

In 1972, Congress first created the Student Loan Marketing Association (SLMA) as a private, for-profit corporation. Congress gave SLMA, commonly called “Sallie Mae,” the status of a government-sponsored enterprise (GSE) to support the company in its mission to provide stability and liquidity to the student loan market as a warehouse for student loans.

However, in 2004, the structure and purpose of the company began to change. SLMA dissolved in late December of that year, and the SLM Corporation, or “Sallie Mae,” was formed in its place as a fully private-sector company without GSE status.

In 2014, the company underwent another big adjustment when Sallie Mae split to form Navient and Sallie Mae. Navient is a federal student loan servicer that manages existing student loan accounts. Meanwhile, Sallie Mae continues to offer private student loans and other financial products to consumers. If you took out a student loan with Sallie Mae prior to 2014, there’s a chance that it was a federal student loan under the now-defunct Federal Family Education Loan Program (FFELP).

At present, Sallie Mae owns 1.4 percent of student loans in the United States. In addition to private student loans, the bank also offers credit cards, personal loans and savings accounts to its customers, many of whom are college students.

What is the difference between private and federal student loans?

When you’re seeking financing to pay for college, you’ll have a big choice to make: federal versus private student loans. Both types of loans offer some benefits and drawbacks.

Federal student loans are educational loans that come from the U.S. government. Under the William D. Ford Federal Direct Loan Program, there are four types of federal student loans available to qualified borrowers.

With federal student loans, you typically do not need a co-signer or even a credit check. The loans also come with numerous benefits, such as the ability to adjust your repayment plan based on your income. You may also be able to pause payments with a forbearance or deferment and perhaps even qualify for some level of student loan forgiveness.

On the negative side, most federal student loans feature borrowing limits, so you might need to find supplemental funding or scholarships if your educational costs exceed federal loan maximums.

Private student loans are educational loans you can access from private lenders, such as banks, credit unions and online lenders. On the plus side, private student loans often feature higher loan amounts than you can access through federal funding. And if you or your co-signer has excellent credit, you may be able to secure a competitive interest rate as well.

As for drawbacks, private student loans don’t offer the valuable benefits that federal student borrowers can enjoy. You may also face higher interest rates or have a harder time qualifying for financing if you have bad credit.

Are Sallie Mae loans better than federal student loans?

In general, federal loans are the best first choice for student borrowers. Federal student loans offer numerous benefits that private loans do not. You’ll generally want to complete the Free Application for Federal Student Aid (FAFSA) and review federal funding options before applying for any type of private student loan — Sallie Mae loans included.

However, private student loans, like those offered by Sallie Mae, do have their place. In some cases, federal student aid, grants, scholarships, work-study programs and savings might not be enough to cover educational expenses. In these situations, private student loans may provide you with another way to pay for college.

If you do need to take out private student loans, Sallie Mae is a lender worth considering. It offers loans for a variety of needs, including undergrad, MBA school, medical school, dental school and law school. Its loans also feature 100 percent coverage, so you can find funding for all of your certified school expenses.

With that said, it’s always best to compare a few lenders before committing. All lenders evaluate income and credit score differently, so it’s possible that another lender could give you lower interest rates or more favorable terms.

The bottom line

Sallie Mae may be a good choice if you’re in the market for private student loans and other financial products. Just be sure to do your research upfront, as you should before you take out any form of financing. Comparing multiple offers always gives you the best chance of saving money.

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Tips to do some fall cleaning on your finances

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Wealth manager, Harry Abrahamsen, has five simple ways to stay on top of the big financial picture.

PORTLAND, Maine — Keeping track of our financial stability is something we can all do, whether we have IRAs or 401ks or just a checking account. Harry J. Abrahamsen is the Founder of Abrahamsen Financial Group. He works with clients to create and grow their own wealth. Abrahamsen shares five financial tips, starting with knowing what you have. 

1. Analyze Your Finances Quarterly or Biannually

You want to make sure that your long-term strategy is congruent with your short-term strategy. If the short-term is not working out, you may need to adjust what you are doing to make sure your outcome produces the desired results you are looking to accomplish. It is just like setting sail on a voyage across the Atlantic Ocean. You know where you want to go and plot your course, but there are many factors that need to be considered to actually get you across and across safely. Your finances behave the exact same way. Check your current situation and make sure you are taking into consideration all of the various wealth-eroding factors that can take you completely off course.

With interest rates very low, now might be a good time to consider refinancing student loans or mortgages, or consolidating credit card debt. However, do so only if you need to or if you can create a positive cash flow. To ensure that you are saving the most by doing so, you must look at current payments, excluding taxes and insurance costs. This way you can do an apples-to-apples comparison.

The most important things to look for when reviewing your credit report is accuracy. Make sure the reporting agencies are reporting things actuary. If it doesn’t appear to be reporting correct and accurate information, you should consult with a reputable credit repair company to help you fix the incorrect information.

4. Savings and Retirement Accounts

The most important thing to consider when reviewing your savings and retirement accounts is to make sure the strategies match your short-term and long-term investment objectives. All too often people end up making decisions one at a time, at different times in their lives, with different people, under different circumstances. Having a sound strategy in place will allow you to view your finances with a macro-economic lens vs a micro-economic view. Stay the course and adjust accordingly from a risk and tax standpoint.

RELATED: Financial lessons learned through the pandemic

A great tip for lowering utility bills or car insurance premiums: Simply ask! There may be things you are not aware of that could save you hundreds of dollars every month. You just need to call all of the companies that you do business with to find out about cost-cutting strategies. 

RELATED: Overcome your fear of finances

To learn more about Abrahamsen Financial, click here

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How to Get a Loan Even with Bad Credit

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Sana pwedeng mabura ang bad credit history as quickly and easily as paying off your utility bills, ‘no? Unfortunately, it takes time. And bago mo pa maayos ang bad credit mo, more often than not, kailangan mo na namang mag-avail ng panibagong loan. 

Good thing you can still get a loan even with bad credit, kahit na medyo limited ang options. How do you get a loan if you have bad credit? Alamin sa short guide na ito. 

For more finance tips, visit Moneymax.

 

 

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