Have you ever completed a process at work over and over, so much so that you don’t even think of the action when you are doing it? For example, your brain goes on autopilot when punching in, then your autopilot turns to get some coffee in the break room. Next thing you know you are sitting at your desk and don’t remember grabbing that cup of coffee? During some recent training of new underwriters at our company I was asked a question about 401K loans that illustrated this to me. I was answering the question with a pre-2011 answer. After auditing some recent loans I can see that I am not the only one that is stuck with a pre-2011 mindset.
Common Error To Avoid
The common error I want to review is neglecting to add in loan payments into the borrowers DTI for loans secured by a financial assets OR getting the required loan documents. For many years of my career both agencies guidelines instructed us that loans secured by financial assets did not need to be counted into a borrowers DTI. When I was asked this question during the training it made me curious to see when that rule changed, so looking up in the older FNMA guidelines I found the rule updated in 2011. Here is a quick shot of pre 2011 and post 2011 from FNMA’s guidelines
FNMA B3-4.3-16 as of 10/30/2009 (Last update of old guideline)
Secured Loans as Debt
When qualifying the borrower, the lender must consider monthly payments for secured loans as a debt. If a secured loan does not require monthly payments, the lender must calculate an equivalent amount and consider that amount as a recurring debt. When loans are secured by the borrower’s financial assets, monthly payments for the loan do not have to be considered as long-term debt.
FNMA B3-6-05 as of 05/24/2011 (First update found on the current guidelines)
Loans Secured by Financial Assets
When a borrower uses his or her financial assets—life insurance policies, 401(k) accounts, individual retirement accounts, certificates of deposit, stocks, bonds, etc.—as security for a loan, the borrower has a contingent liability.
The lender is not required to include this contingent liability as part of the borrower’s recurring monthly debt obligations provided the lender obtains a copy of the applicable loan instrument that shows the borrower’s financial asset as collateral for the loan. If the borrower intends to use the same asset to satisfy financial reserve requirements, the lender must reduce the value of the asset (the account balance, in most cases) by the proceeds from the secured loan and any related fees to determine whether the borrower has sufficient reserves.
How to apply this guideline
As you can see there is a difference between these two updates, the main issue I see during reviews is the paystub will show a 401K loan deduction or the 401K statements shows an open and active loan and this debt is not added to the borrowers DTI. Based on the guideline if I don’t see the 401K loan added to the liabilities, my next step is to find the loan instrument from the employer or fund manager outlining the terms of the loan and confirming the asset that secured the loan. As I stated previously, I can tell I am not the only underwriter who sometimes has in brain back in pre-2011 since a few of the loans I am reviewing are missing this information. When I ask the question why the 401K loan was not added to the debt, I hear the pre 2011 response from the underwriters.
Hopefully this quick blog helps you shake off some the old habits, I know that I need to keep working on this one myself.