The Black Box Called American Loan Underwriting

You see, i am a small business owner and I am self-employed. That means that I co-mingle business and personal facilities and payment mechanisms. In my recent sojourn to refinance my mortgage as well as obtain SBA credit for my business, I came across a number of issues that appeared to be the result of a lack of common sense. Either this or active lobbying by the banks to the detriment of everyone else. 

Lets first look at the process of underwriting. The underwriter, much like the undertaker, seems to be someone no one wants to deal with or, after you pay them, you are dead and buried. Most times you receive a denial of your loan, they point to your credit profile. But here’s the problem, the underwriters use your credit score as only one tool and look at a number of other ratios including debt to income, net worth etc. No one knows how these ratios are calculated and how the use these ratios. We are not given a report that explains the method of calculation and the full set of ratios, and not just the credit scores, used to arrive at the final credit decision. This clearly also means that underwriters at the retail level do not properly explain the risks inherent in servicing or you obtaining a loan. You thought that you got denied or approved because of your credit scores, only to realize later that several other factors went into it. When credit is denied, it is mandatory for the banks to send you a letter explaining the reasons and your right to obtain copies of your credit report. All good, but what about the debt to income calculations or net worth calculations, and what about the weights used in these calculations – we dont get to see any of that. It is clear that in this economy, credit is being denied to even people with excellent credit scores. This clearly means that the risks are not limited to your credit scores alone. Yet, we dont get to see the overall calculations that an underwriter supposedly uses. This is hardly a transparent process. 

The second issue I faced was how income is calculated. Are we that primitive that we cannot use well-reasoned formulas to calculate one’s income? Do we always have to use the adjusted gross income on your tax returns as the income? Many small business owners employ tax minimizing strategies that are perfectly legal. They may show more deductions in their business P&L especially if they run a home-based business. But the reality is that these deductions are in fact income because the small business owner generated those revenues in the first place. How hard is it to understand what needs to be construed as income? Anything that pays MY bills in a home-based business is MY income. I am astonished these so-called underwriters and government agencies have adopted myriad rules and red tape that defines what MY OWN income is. I mean, here I am earning enough to pay my bills and I am actually being told by the underwriters that I do not have enough income. What a farce! Accountants are better placed to certify what a person’s disposable income is. What is the need for a government agency such as the FHA to adopt measures that deny you your own income? Are they penalizing me for adopting a tax minimizing strategy? Things are strange indeed! 

The third issue I face is not knowing what part of the undertaking process is done by the banks and what part is completed by a guaranteeing organization such as the FHA. When banks don’t want to deal with even moderately risky customers, they seem to pass the buck onto these guaranteeing organizations. During my quest to get my income defined better, I contacted the FHA, only to hear an employee read out a paragraph from the rules book that there is sufficient flexibility in determining what constitutes an individual’s income, in the self-employed scenario. Armed with this information, I suggested to underwriters that more transparency is required in the way they calculated the debt-to-income ratio. Again,to no avail, these folks simply refused to account for the real income. For instance, if the income were to be calculated the way the underwriters suggest, our country’s Gross National Income would be half of what it is statistically recorded now. Basically, the banks are denying me my income and refusing to accept my value creation in the economy. How ironic it is that I have to hear this from institutions that have destroyed so much value?!

The need of the hour is to institute a transparent underwriting and disclosure process, educate consumers more about their full financial profile – not just their credit scores, and use better methods of accounting for income. Credit reforms are a must to ensure less volatile financial markets. American savings rate could enter double digits if the economic uncertainty continues to roil and the unemployment rate remains high. In such scenarios, a credit score-based lending would make even less sense. Banks know that but will consumers get a full disclosure?