Lenders Incur Visible Risk from Hidden Borrower Debt

Over the past few years, lenders and underwriters revamped their standards to reduce risk, but Equifax says there’s one challenge many lenders still have difficulty combating—undisclosed debt.

In a recent white paper, Equifax published results of its research into undisclosed debt and its recommendation for how to deal with this difficult hazard. Ultimately, Equifax said, “The results are somewhat surprising and disturbing.”

“Undisclosed debt poses a risk even for lenders with conservative underwriting standards, experienced professionals, and credit-worthy applicants,” Equifax asserted in its paper.

Nearly one-fifth of borrowers apply for at least one new line of credit during the period between their credit profile review and the closing on their mortgage loan—deemed the “quiet period” by Equifax.

While some homeowners sign up for store credit as they purchase new furnishings or household items—not realizing this could impact their credit—others intentionally apply for multiple mortgage loans at the same time.

“Most borrowers are honest, but whether undisclosed debt during the quiet period is intentional or not, it poses a threat to lenders, regardless of their underwriting process,” said Craig Crabtree, SVP and general manager of Equifax Mortgage Services.

About 36 percent of borrowers who opened at least one trade line during the “quiet period” increased their debt-to-income ratio by at least 3 percent, which is significant for lenders.

“For lenders, undisclosed borrower debt incurred during the underwriting process presents a very real risk, since a 3 percent or more increase in borrower DTI can result in expensive loan repurchase demands by the secondary market or penalties by regulators,” Equifax stated in its white paper.

Borrowers with the highest and lowest FICO scores tend to present less of a risk when it comes to undisclosed debt, according to Equifax. Those borrowers most likely to incur undisclosed debt during the “quiet period” are those withFICO scores between 620 and 720.

Some lenders attempt to prevent undisclosed debt by pulling a borrower’s credit profile again immediately prior to closing, but as Equifax points out, this can be cumbersome and inefficient. Instead, Equifax recommends continual credit monitoring throughout the application and closing process. Lenders can receive daily alerts of borrower credit activity and can adapt as needed.

“With early warning, lenders can proactively discuss the impact of new debt with the borrower, obtain additional documentation needed for the secondary market, or change the terms of the loan,” Crabtree said. “Lenders who are able to continuously monitor credit activity during the quiet period can significantly reduce their buy-back risk and provide much better service to borrowers.

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