TheMReport — News and strategies for the evolving mortgage marketplace.
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24 | Th e M Rep o RT Feature industry veteran knows that there is not, nor has there ever been, a standard that is used to calculate income. And income, of course, is used to determine ATR's back-end ratio (or DTI). Today, we see many under- writers using a legal pad and a calculator to create the income figure. More sophisticated lenders, meanwhile, rely on spreadsheets that accommodate for wage and non-wage earnings, recurring and non-recurring income/expenses, and other anomalies found when reviewing the hundreds of pages of tax transcripts, tax returns, pay stubs, and bank statements. Just saving the spreadsheet to docu- ment income does not mean that there is consistency as to how the income was determined or the accuracy of that calculation, as the teams performing QC can attest. The ATR guidelines them- selves do little to crystallize the calculations beyond the guide- lines already published by the GSEs. For example, Appendix Q requires the lender to evaluate the financial strength of the busi- ness operated by a self-employed consumer. "Annual earnings that are stable or increasing are acceptable, while businesses that show a significant decline in income over the analysis period are not acceptable4." That makes sense, but what constitutes "stable" or "significant"? Similarly, in considering over- time and bonus income, "A peri- od of more than two years must be used in calculating the average overtime and bonus income if the income varies significantly from year to year." How many differ- ent rationales and interpretations of those rationales are possible? How will a judge rule based on this wording? What happens once the court rules against a recurring bonus or commission? Can anyone say, "Headmaster Dolores Umbridge?" And the CFPB's proposed post-consum- mation cure for DTI miscalcula- tions (wherein the lender would be responsible for buying down the debt or reducing principal to achieve an acceptable DTI) is akin to Umbridge's "I shall not tell lies" punishment on Harry. Our analysis on a large population of already closed and funded loans showed that at least one in five had an income calculation discrepancy. More importantly, of those loans with income discrepancies, more than 10 percent of the incorrect calculations were of a grievous variety. In these cases, there were many that could justly be recategorized as non-QM because of the recalculated ratios and affordability. In speaking to our clients about this risk, each agreed that they weren't doing enough to first correctly calculate the borrower's income and, sec- ondly, properly document how that figure was calculated. At any point in the future, the first question the opposing attorney will ask will be the same one we used to dread from our math teachers: "Show me your work." Proper documentation has to include the math behind the cal- culation; an explanation of what was included and why; and an explanation of what was not included and why. Moreover, to prove the lender is not using de- ceptive practices, that math has to be the same on each and ev- ery loan file manufactured. The second question that attorney is going to ask is, "Prove to me that you calculated the income of my client in the same manner you used on other loans." If there is a discrepancy, there will be further burden on the lender to prove each variation of the calculation was correct. Due to the variability in how income is calculated, it is prob- ably safe to say that there isn't a lender today who has a 100 per- cent, litigation-proof, documented loan file. In fact, one top-three bank revealed to us that they calculate a borrower's income no less than seven times before the loan is closed, and then at least once more if that loan is selected for a quality control review. And, prior to close, the multi- tudes of calculations are repeated if any one of them results in a different income amount. It is no wonder the industry's cost to produce a loan has increased by more than 250 percent in the last few years. And, worse yet, eight-plus calculations per loan still does not eliminate the risk a borrower will claim they could not afford their loan. Bad things happen to good people and some loans will go delinquent, even when under- written to today's stringent stan- dards. Our industry's challenge is to have an indisputable means in which we can prove that when that loan was made, the borrower absolutely could afford it. Not even Harry's invisibility cloak can save us from the litiga- tion we may see. 1 Bloomberg report by Carter Dougherty and Elizabeth Dexheimer, Oct. 21, 2013 2 § 1026.43(e)(1)(ii) 3 § 1026.25(c)(3) 4 Appendix Q to § 1026, Section I.B.3.b Jonathan KunKle is president of GuardianDocs, the document services division of Denver-based LenderLive Network™ Inc. He can be reached at Jonathan.Kunkle@gts.com. "QM can provide the originator a safe harbor, but they're never really safe. There are foreclosure defense attorneys in the country just waiting for the opportunity to spring their trap on the lending industry. That trap is: 'prove to me my borrower could afford this loan.'" — Paul Schieber, Stevens and Lee