Lenders originating loans for secondary market sale are required to conduct quality control (QC) reviews on their loan packages. Quality control is an independent re-underwrite of a loan file and verification that the loan complies with both regulatory requirements and investor guidelines.
At the pre-closing stage, QC should be conducted by someone who has had no previous involvement with the loan file. One loan officer can review another loan officer’s file and still meet independent review guidelines.
However, at the post-closing stage, the reviewer and their manager have to be completely independent of the loan production process.
QC validates that all conditions have been met and that the loan will be sellable on the secondary market. To be effective, QC should be considered a training tool and not a “gotcha review”; we’re all human, and mistakes happen, especially in this current environment where volumes of loans have increased significantly. Avoid creating a culture in which your internal reviewers feel the need to hide errors in order to protect their peers.
Why is quality control so important right now?
More and more investors are requiring proof of a quality control program. Demonstrating effective QC helps you avoid scrutiny and maintain investor opportunities.
An effective review process improves loan quality and production processes and identifies areas for training and improvement. It confirms prudent underwriting decisions are being used and verifies the existence and accuracy of all documentation used in the underwriting decision.
Who is responsible for quality control?
The short answer is: You are. Some lenders will say, “My investors perform quality control.” Or, “My correspondent bank performs quality control.” That’s true, but it does not alleviate the financial institution that originated the loan from performing (or arranging for) QC on their files.
If you choose to outsource your quality control, you are still responsible for validating that the person or company performing your QC has the appropriate qualifications and experience and is completing the review within the required timeframes.
Income: Common errors and red flags
Borrowers need to complete all requested income and employment questions. Missing details such as date of employment, date of last pay increase or employer address can all create problems when attempting to send a loan out for reverification.
A borrower’s employment and income are indicators of their ability to make loan payments. Look for common red flags such as indications of unreported self-employment, evidence of an edited W-2 or an employer that cannot be verified.
Borrowers who are self-employed, or employed in a family business, require extra analysis in the lending process. If the borrow has not disclosed this, be on the lookout for clues such as:
- The name of the business has some or all of the borrower’s name or initials (e.g., borrower John Q. Smith works for Smith Investing or JQS Enterprises).
- Spouses who work for the same small company.
- Verification of employment (VOE) is directed to an individual versus a human resources department — this isn’t necessarily a problem if the employee works for a small company, but it merits investigation.
Look for evidence that the borrower may have falsified income reports by editing their W-2. Reg flags include fonts that don’t match throughout the document or numbers that appear to be squeezed on to the form. Additionally, be on the lookout for earnings in rounded dollar amounts as that does not typically occur naturally.
1003 loan application: Common errors and red flags
Maintain data integrity by completing all fields on the 1003 form. Details should be cross-checked against title documents. In figure 1 above, we see the application is missing the zip code and a legal description of the subject property. This can make it difficult to verify the information against the title documents.
For refinanced loans, be specific about the purpose of the refinance. “Tell the story” of what the loan applicant is doing (e.g., debt consolidation, buying a second home, etc.).
In figure 2 we note that marital status is not completed. This information is important for issues like title theft, spousal acknowledgment of a mortgage, or spousal support obligations.
Number of years at the present address is also blank, although from figure 1 we can see that the mortgage loan was first acquired in 2019. The instructions say that if the applicant has lived at their present address for less than two years, a former address is required.
In addition, the address of the employer is missing, so the reviewer will be unable to reconcile the data on the 1003 to the VOE.
In the written VOE (not shown), we noted that the applicant’s employer reported past year earnings of $54,170, of which $1,500 was overtime and $4,750 was bonus. The VOE also indicated that overtime was not likely to continue.
In figure 3 we see that income (salary, overtime, bonus) has not been broken out; this will generate an error when put through an automated underwriting system. It’s important to tell the investor the full story of where an applicant’s income is coming from, and what the income is expected to be in the future.
Also in figure 3, we see a simple human error in which hazard insurance and real estate taxes have accidentally been dropped from the proposed housing expense.
In figure 4 we see the applicant pays support of some sort, but not who it is owed to. This is a data integrity violation.
In figure 5, question “m,” the borrower indicates they have not had any ownership interest in a property in the last three years. But as we know, this is a mortgage refinance and the answer should be “yes.”
Verification of deposit/source of funds: Common errors and red flags
In figure 6 we see the current balance in the savings account is significantly higher than the balance for the last two months. If you need the source of funds to close the loan, then you will also need documentation as to where that large deposit came from. Even if you don’t need the source of funds to close the loan, you can’t just ignore the balance fluctuation. If you’re aware of the information, you must address it, but you generally can get by with a letter of explanation from the borrower as to why there was a significant increase.
Other red flags we see in source of funds include:
- Squeezed numbers on documents.
- Canceled check encoding doesn’t match the amount on the check.
- Discrepancies in names of the account holders.
- Unusually large gifts by non-family members (i.e., this could signify a loan).
- Computer-generated account statements.
Best practices in secondary lending quality control
- Pre-closing QC staff should have authority to prevent a loan from closing until all deficiencies are cured.
- Actively share information and data between pre- and post-closing functions. Watch for areas that may need investigation and/or additional targeted reviews.
- Obtain tax transcripts as part of the origination process.
- Limit the number of documents left to be collected at closing so that the loan is not inadvertently closed without required information or supporting documents.
Above all, tell your story. Your investors want to understand how the borrower is using the money, the extent to which you verified the information provided and the level of analysis completed before approving the loan.
How Wipfli can help
Wipfli offers secondary market quality control services. When you outsource with Wipfli, you get the benefit of knowing your QC is completely independent and that everyone doing the QC has the necessary underwriting background and knowledge to do that work.
If you prefer to keep the QC process in house, we can assist your internal staff with development of your policy and testing procedures to help them become more proficient, and ensure they are consistent with investor guidelines. We can also help you stay current on best practices in secondary market quality control, so you can proactively make procedural changes to your QC program.
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