First off let’s get the obvious out of the way. I am a human loan originator. AI loan origination will threaten many loan originators business. Realistically, by the time it is 100% going I will be retired. It is important to note this is not an article defending my job but rather a warning of things to consider. If you are developing AI that will do loan origination I urge you to take the following into consideration when designing.
How AI Loan Origination could lead to our next financial crisis
I spend the majority of my day talking to my clients about their current financial state and long-term financial goals. I discuss debt to income and walk them through what debt to income means and how it can affect them. This is a conversation, not a script. It is individual to each client and their psychology regarding money and current financial and emotional state. I do this because I want their home to be a joy and not a burden.
As the housing market constricts more lenders are coming out with more accommodating guidelines. To be blunt, current guidelines for some loans allow the debt to income to be so high that it can put the buyer in a terrible position if one thing with their income goes wrong. With an FHA loan the guideline allows to up to 55% debt to income. We calculate this off of gross income. Gross income is pretax income. Think about it. 55% of your gross income would go to your housing and any debt on your credit report. We are not calculating your child care cost or monthly expenses such as electricity, food and gas. This 55% is just housing and what is on your credit report and your new housing payment. Not scared?
Let’s do some math
$72,000 a year income / $6,000 a month gross
Federal taxes, state taxes, medical insurance, social security etc… etc… etc…; $1,391
Less Housing and credit debt: $3300
You have $1309 left for EVERYTHING else.
Now if you have children in daycare of private school deduct that
Commute to work? Deduct your gas
Now do everything else
Where does that leave you?
Do you have anything left to save for retirement? What about college? What about a vacation? What about food?
If I am working with a client whose debt to income is in that range, we are going to have a full conversation and work out the numbers, so they make sure they have enough to live on. A higher debt to income realistically only makes sense if there is some other income we are not counting. Perhaps they have only been getting overtime for a year or we cannot use their spouse’s income because they are not on the loan. In cases where there is more income we are not using, going to the max debt to income allowed for the program can make sense, but without extra income it is a recipe for disaster.
An originating computer will underwrite and approve your loan based off of max guidelines. For long term financial health going with the max guideline is never a good idea as evidenced above. Now imagine a nation where everyone is qualified to their max. What does that look like? Look at the math above again if this concept does not frighten you.
It is not pretty. Consumer spending will be down because there is no money to spend. When consumer spending goes down then jobs get affected. Jobs get affected and then…. Short sales, Foreclosures and Bankruptcy OH MY! This is an incredibly simplified view point but think it through.
The argument is that people will not get themselves into trouble. Let me remind you our current educational system does zero financial education. ZERO. We cannot just assume everyone understands what the numbers mean or even what they can afford. I am in the “trenches” every day talking to people about money. It is not pretty. I have had hundreds of conversations where I have needed to explain multiple times that buying a house with a payment more than what someone takes home will not work. I know this sound unbelievable, but it is real and true and a result of our country’s lack of financial education.
As of now I have yet to see a program where it shows the client what their debt to income is and provides any sort of counseling. The computer is merely matching up the borrower to the max. Want to know your max? Great the computer will give it to you. Realistically, even with a digital counseling how many people are going to read it? Have you ever read the Apple terms of service? Do you read it every update? The only chance would be an interactive counseling that has a lot of video that is required to get your preapproval letter. Even then once they get a letter to buy their “dream” home how many people will pause to think about the math?
Tech is revolutionizing the mortgage industry. A loan from start to docs in 7 days is becoming easier every day. This is all due to tech. We are on the path to AI mortgage origination. I am looking forward to Jennifer 2.0 doing loan origination. I just pray she educates and cares about her clients and that the mortgage industry understands what they are unleashing.