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AU, Borrowing Costs and the Profitability of Mortgage Origination

December 1, 1996

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AU, Borrowing Costs and the Profitability of Mortgage Origination

If the mortgage underwriting and origination markets are competitive, borrowers whose loans no longer need extensive human involvement could benefit from the lower costs that automated underwriting (AU) will produce. In the long run, it could be cheaper to have an automated system review the home loan in place of a human underwriter. Borrowers whose risk of default had been overestimated by less sophisticated underwriting methods would receive extra savings if AU systems find that they qualify for interest rates available for lower-risk borrowers.

But, borrowers who were previously being undercharged relative to their risk of default will see their costs rise if these systems allow for a better link between mortgage rates and borrower risk. Moreover, those borrowers whose applications would still undergo a full human review—those that the systems identify as falling into a "gray" area—may not benefit from cost savings. Indeed, their costs could increase if these borrowers alone bear fixed costs associated with human underwriting that had previously been spread among all applicants.

These systems could also pose a threat to the profitability of mortgage lending. In an underwriting environment where most loans are reviewed by automated systems and more communication occurs electronically, the professional mortgage banker and underwriter could play a more limited role and thus would provide less value in the origination process. Over time, firms without direct mortgage banking experience, such as financial planners or real estate agencies, could gain access to AU systems. The automated systems can make these underwriting neophytes, as well as less efficient mortgage bankers and those with limited technical capabilities, into sophisticated, cost-effective underwriters. Because of the increased competition and because they provide less unique skills in the automated environment, some industry experts believe underwriters and origination firms will ultimately receive lower compensation for their work.

Not all originators will become less profitable because of automation. A significant number of mortgages will still need human attention. In addition, lenders with automated systems could increase their loan volume. Finally, data gathered by the automated systems could be "mined" for information that allows lenders to better target their sales of other products and services.

photo of Ron J. Feldman
Ron J. Feldman
Senior Financial Specialist

Ron Feldman is first vice president and chief operating officer at the Federal Reserve Bank of Minneapolis, where he leads Bank operations, including finance and budgeting, strategic planning, workforce and talent development, and performance against strategic objectives.

Feldman is also a primary adviser on monetary policy, playing a leadership role in preparing for Federal Open Market Committee meetings and in the development and communication of positions on monetary policy.

An expert on financial institutions and related government policies, Feldman has authored more than 50 articles on topics related to banking, finance, and monetary policy. He is one of the foremost authorities on the too-big-to-fail problem, co-authoring Too Big to Fail: The Hazards of Bank Bailouts, published by the Brookings Institution (2004).

Since joining the Bank in 1995, Feldman has served as a senior officer for Supervision, Regulation, and Credit and has run the Financial Services Support Office, which assists in the oversight of the Federal Reserve’s financial services.

He has a B.A. with distinction from the University of Wisconsin and an M.P.A. from the Maxwell School, Syracuse University, where he was a university fellow. He is a fellow of the National Academy of Public Administration.

Feldman is married and the father of three children. He is an active community member, serving on the boards of Second Harvest Heartland, the Talmud Torah of Minneapolis, and Ready, Set, Smile. He is on the Board of Visitors for the University of Wisconsin-Madison History Department.

 November 2019