How to Avoid the Headache of Undisclosed Liabilities

Assessing a borrower’s ability to repay their loan is key to accurately evaluating the risk of any mortgage loan. 

The debt-to-income calculation that helps lenders evaluate a borrower’s overall ability to repay is rendered inaccurate when a borrower doesn’t disclose all their existing liabilities, including new debts opened after application, for consideration in qualification. This can cause a headache for both you and your borrower during the loan process or even after the loan has closed and funded.

Undisclosed debts are defined by Fannie Mae as “any loan or liability (e.g., auto, revolving, installment, mortgage, or lease) that exists at the time the borrower closes on the subject loan and is not disclosed by the borrower during origination.” We’ve added the emphasis on the phrase “exists at the time the borrower closes” because it’s a good reminder that we must be aware of any new debts or liabilities that the borrower may incur all the way through closing.

Borrowers can, and frequently do, incur new debts after submitting the initial loan application and/or after an initial credit report has been pulled, but prior to consummation. Without proper borrower education by knowledgeable mortgage personnel this type of headache can start to become more of a recurring migraine for your institution. These undisclosed debts are not factored into the borrower’s qualification and final approval, which raises the prospect of violating an investor’s underwriting requirements.

By educating your borrowers and mortgage personnel on the risks of undisclosed liabilities, you can protect your borrower’s loan approval as well as your institution’s mortgage income; avoiding a potential headache for all parties involved. Non-compliance with secondary market investor requirements is clearly not desirable due to the potential for repurchases, indemnifications or, even worse, the suspension and/or termination of selling arrangements (which can occur with repeat breaches of your lender contract with your investor).

To put it simply, investors require that all debts and liabilities, whether opened prior to or during the loan origination process, be factored into the final approval of a mortgage loan. Proper and complete analysis of a borrower’s ability to repay is crucial in accurately assessing the risk of any mortgage loan. This also ultimately helps predict the performance of any mortgage loan and therefore the overall suitability of a loan for sale on the secondary market. 

Below we have listed some potential solutions that your institution can easily implement in order to avoid landing in this type of predicament.

Simple Solutions to Avoid the Undisclosed Liability Headache

Loan officers and processors should consult with each borrower and educate them on the importance of reporting all debts and avoiding incurring new debt during the mortgage process. 

Everyone who interacts with a mortgage borrower should stress the importance of complete transparency when it comes to income and debt disclosure. Don’t be shy about explaining how new loans, such as an auto loan, could cause their debt-to-income ratio to increase to a level that makes them ineligible for their loan program.

Regularly check in with borrowers throughout the origination process and ask if there have been any changes to their financial situation since the last time you spoke.

• Soft pull a credit report one week prior to the scheduled closing date and review it for any changes in the borrower’s debts and liabilities.
• Highlight the legal obligations referenced in Section 6 of the new URLA when borrowers sign the final loan application at closing.
• Track this deficiency in QC in order to identify trends and administer a feedback loop to mortgage origination staff.

For more tips on preventing undisclosed debts and liabilities, check out the July edition of Fannie Mae’s Quality Insider publication.