Tuesday, August 31, 2010

The Importance of Avoiding Disputes

Remember when our parents used to drill into us that we should make every effort to live at peace with everyone and stay out of conflict whenever we could?  Some parents, like mine, followed that basic message with a second message: if somebody attacked us first we needed to defend ourselves. But that second admonition was only to be used if all of our efforts to avoid conflict had failed.  For most of us the basic message was clear--stay out of trouble if you possibly can.

Today, Fannie Mae has taken on the role once held by our parents of reminding us that disputes are bad.  No, I am not talking about the fight with the school yard bully at recess, or the on-going conflict with the neighbor who refuses to clean up the weeds and trash in his yard.  I am talking about disputed items on a credit report, which due to Fannie Mae's new guidelines have turned into a real problem for borrowers looking for conventional financing.

A few years ago, disputing items on credit reports was all the rage.  I have had borrowers with mobile phone accounts that they insist they never opened, utility bills they claim they never signed for, apartment leases that their ex-boyfriend/girlfriend was supposed to pay, etc.  Most people with collections on their credit report are fairly insistent that those accounts do not belong to them.  And in some cases, that is true.  We live in an age where identity theft is a huge business--from online hackers with spyware looking to steal account numbers and passwords to waitresses and waiters who are able to make copies of credit cards at restaurants, this society is filled with people who are benefiting financially from destroying another person's credit.  In some cases, the problem does not stem from something as sophisticated as formal identity theft but the account being billed does deserve to be disputed because it was double billed or previously paid, or the service or product being billed for was never supplied. 

Filing a dispute has been a fairly easy process since the three major credit bureaus became more accessible through their websites.  A consumer disputing a tradeline needs only to go to the website of the credit agency in question, order a copy of his own credit report, and then click the dispute tab to have the bureau investigate it.

While the dispute process has many legitimate uses, we also recognize that, as with many good things in this world, the process has been exploited and abused by credit repair companies who dispute all of the derogatory items on the credit report so that the creditors will have to respond to the credit reporting agencies' request for information.  The creditor is supposed to respond within 30 days, and if he fails to respond the agency is supposed to remove the item in question.  Of course, this is a very short-term fix because when the creditor does respond, the offending item goes right back on the credit report, but it has been used to artificially elevate credit scores very briefly so that borrowers who really do have very bad scores can temporarily raise their scores enough to get a loan.

Scams like these must have been what prompted Fannie Mae to make its new rule about disputed items.  A borrower with a disputed item on a Fannie Mae credit report must now have the dispute removed before the loan can close or else the credit score cannot be considered in underwriting. 

I had read about this a couple of months ago, but I was confronted with it this week as I was getting files ready to refinance.  One borrower in particular has basically good scores, extremely high income, low debt in relation to his amazingly high income, and a lot of assets.  He also has a few collection accounts which he refuses to pay.  I wanted to make sure that he would not be required to pay these accounts at closing (I have done quite a bit of work for his family and I know that he would rather not refinance than pay collection accounts, so I wanted to find this out first), so I started by running his file through the automated underwriting system to make sure that he could leave the collections unpaid.  And then, as I stared in amazement at my findings, I remembered what I had read about the disputed accounts a couple of months ago.  My borrower does not have to pay his collections because they total less than $5000.00, but in spite of his wealth, basically good scores, and low debt, he cannot get approved for this refinance because he disputed two of the accounts, which combined total less than $500.00 unless he removes the dispute from each credit reporting agency.  Removing a dispute could take months, and he is only refinancing to take advantage of the low interest rates right now.

The item he is disputing is a charge from an insurance company that he insists he does not owe.  The account is a couple of years old and is insignificant when compared to the rest of his credit history.  But here is the most amazing part--even if my borrower decided that the new refinance was more important to him than this measly collection and paid the collection account in full, Fannie Mae still would not give him the loan!  Even if the bill has been paid, if the account is on the credit report showing that it is in dispute, the credit scores cannot be utilized.  And since accounts stay on a person's credit report for seven years from the date of last activity, this account will be there a long time.

Yesterday I talked about how strict new underwriting guidelines are making it nearly impossible for even good borrowers to qualify for mortgage loans, and this new underwriting rule about disputes is another example.  I have no doubt that this rule was implemented to weed out weak borrowers who artificially inflate their credit scores by disputing items on their reports.  But, in an effort to sift out these borrowers, Fannie Mae is also punishing borrowers with long credit histories and scores that are reflective of how they have managed their credit over time but who have had a legitimate disagreement with a creditor.  The result is that borrowers like mine who are a good credit risk, have the income and assets to pay, and have a long, mostly clean credit history, get their loans denied.

In checking around, I learned that Freddie Mac does not have this same rule, so the file can be sent through their automated engine instead.  For my borrower, that means losing his interest rate lock since the lender I was going to use does not allow his specific loan product on Freddie Mac.  Fortunately, the rates are still low and we can salvage this deal.  But in a market with volatile rates, this would have cost him the opportunity to refinance and take his 15 year mortgage loan down to a 10 year while knocking nearly a point off his rate.

The morale of the story:  1.  Read the credit report carefully before you submit the file to see if there are any disputed accounts--even closed ones.  2. Remember Mom and Dad's words of wisdom and where ever possible, avoid disputes.

1 comment:

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