Earlier this year, March to be specific, I wrote a column about how much I hated Payment Option ARMs and the problems those loans could present. After I got through all the hate mail from loan officers telling me what an idiot I was and how the Option ARM was perhaps the greatest loan invention known to mankind I realized there's a compounding problem: Automated Underwriting Systems.

We all know that loans are approved or not approved by computers these days. These applications, called Automated Underwriting Systems, or AUS, were developed several years ago for use by lenders to get an instant loan approval. Instant as in "seconds."

All a lender or loan officer had to do was input a standard residential loan application into these systems and after a few moments, Presto! Loan approval. The borrowers wouldn't get to rush right in and begin moving furniture right away. No, they would have to verify their application by physically providing pay stubs or bank statements or mostly whatever the AUS required of them. The big change with an AUS was the loan was approved first, then documented later compared to the traditional document to death first, then approved later, then document some more.

There are two primary systems developed for and by Fannie Mae and Freddie Mac. Fannie's AUS is called Desktop Underwriter, or DU, and Freddie's nickname is Loan Prospector, or LP. But Fannie and Freddie both share the same loan limits, currently $359,650. What about loans that are higher than that amount, say for example all loans from California? Well, lenders can use those applications for Jumbo and "boutique" loans as well. No, those loans won't eventually be pooled for sale to Fannie or Freddie but those individual loans can receive an "approval" by using their underwriting system.

Fast forward. It seems every other column written about housing lately addresses a housing bubble and how dangerous Option ARMS are. Or can be. But let's throw something into the mix: automated underwriting and these new loan programs.

DU and LP became famous when things were going well. In fact, give or take, things have been going pretty well for the past decade or so. We hit some slow economic times, but home ownership continued to increase, all the while interest rates were kept low.

Come to think of it, these AUS applications have only been effective in "good" economic times. They've never been tested when times weren't good. Now, I'm not suggesting by any stretch of the imagination that our economy is heading south. No, I'm only suggesting that if in fact housing prices do decline, will homeowners default earlier because the AUS didn't take into consideration the possibility of home value depreciation?

Here's the deal with an AUS. With good credit or lots of cash reserves or sky-high credit scores, home loans are being approved over the past few years that no human underwriter would ever let cross his or her desk. Routinely, Fannie Mae's and Freddie Mac's AUS applications approve loans with ratios in the 60s. Or higher. Many a loan officer can tell stories of loans that were approved that had they been submitted a few years ago prior to DU or LP they wouldn't have made it to first base under an underwriter's scrutiny.

Not that this is a bad thing. There are no major foreclosure problems because of an AUS. And we're sitting at record homeownership levels. I'm only suggesting that IF a housing bubble does indeed burst, will loans go bad that were approved by an AUS that would not have been approved by a real, live human being?

We don't know. Automated Underwriting Systems haven't been really tested. So far, they've worked fine, riding right alongside historically low interest rates, unemployment rates between 5 and 6 percent, little to no inflation, skyrocketing home values and omnipresent worker productivity gains. But what if suddenly things aren't so rosy? Are lenders using an AUS in lieu of common sense underwriting?

Published: September 2, 2005

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, a veteran Mortgage Banker, successful Real Estate Consultant and author of Your Guide to VA Loans, Mortgages 101: Quick Answers to Over 250 Critical Questions About Your Home Loan, Who Says You Can't Buy a Home!, and Mortgage Confidential: What You Need to Know That Your Lender Won't Tell You, is a former columnist and Contributing Editor with San Diego-based Mortgage Originator Magazine. Reed is President of CD Reed Mortgage Bankers, Austin, TX and is a Past President of the Austin Mortgage Bankers Association.