Understand Top Defects to Help Strengthen Loan Quality

Misrepresentation of primary occupancy 

• The borrower’s intent, per the loan application, is for the subject property to be utilized as a primary residence. Upon review, data confirms the subject property was listed as a rental property after the closing date, or the insurance policy includes language – such as “rent loss coverage” – that is indicative of a rental property.
• This defect has consistently been one of the most frequently cited over the last 12 months.

• Loan officers, as the first line of defense against occupancy misrepresentation, should know their borrowers and ask situational questions. Be aware of common occupancy red flags and reinforce the commitments and legal representations that borrowers must make when they sign the loan application.
• Assess whether the purchase of the property aligns with the borrowers’ current living situation. Are borrowers buying a 1,200 square foot house when they already own a 2,500 square foot house? Are they moving from a 5-bedroom house to a 2-bedroom house?
• Evaluate the location of the subject property and its proximity to the borrower’s employment. Consider the type of position and if it supports remote employment. If a borrower is buying a primary residence in a different state from where they own a business, consider whether their income is likely to remain stable and whether the occupancy representation is plausible or likelihood of primary occupancy.
• Underwriters should review the file holistically, including tax returns, bank statements for evidence of rental income, credit history for multiple mortgages, and the homeowner’s insurance declaration page for language that suggests the property may be a rental. If the borrowers own a home, confirm what its status will be after closing.
• Consider implementing a separate borrower attestation process – distinct from the loan application – reinforced with pre-closing confirmation to document the borrower’s intent to occupy the subject property as a primary residence.
• For additional best practices, review this Quality Insider from 2024.

Omission of debts documentation missing/insufficient

• A financial obligation was listed on the loan application or is identified on bank statements, tax transcripts, title work, or other documents but it was not included in the debt-to-income (DTI). No documentation was included in the file to exclude the obligation from the DTI; and the inclusion of the obligation led to a DTI exceeding eligibility thresholds.

• Lenders must review all file documents used to quality the borrower (per the Selling Guide B3-6-01) to ensure all required liabilities are included in the DTI.
• Loan officers should review credit reports with borrowers and ask if there are any financial obligations that are not shown on the credit reports.
• Underwriters should include property documents in the review; condo questionnaires and appraisals may note the existence of solar panel payments, special assessments, or liens.
• If borrowers provide documentation to exclude a liability, confirm the documentation demonstrates that they are not responsible for the payment. Determine whether another party pays the obligation, or if it is paid in full.
• Review the asset statements to identify any recurring payments to a creditor. Obtain information to confirm the terms of the obligation and the borrowers’ responsibility.

Incorrect income calculation – rental income/loss and
Income not documented – rental income/loss

• Rental income calculations and documentation requirements differ depending on the property type, documentation available, and occupancy. As a result, these defects include multiple root causes, including missing lease agreements, which are often required to include rental income in the DTI calculation; missing tax returns, which are required to include a rental loss in the DTI calculation; and a lack of rental history, which is sometimes required to include both rental income and/or loss in the DTI calculation.

• Establish rental income eligibility, and confirm that it can be documented properly, before calculating the income.
• If Form 1007 is involved in the rental income calculation, compare the expected rent as stated to the lease provided by the borrowers.
• Include your rental income calculation in the file documentation as support of your determination in case the file is reviewed after closing.
• If you have tax returns, utilize Fannie Mae’s Income Calculator to calculate rental income and potentially receive rep and warrant relief on the calculation.
• Review Fannie Mae’s best practices to calculate rental income.