THE RISK-RATING PROCESS
- The many individual factors which contribute to
risk have been combined and grouped into a few significant relation-
ships which are called “features” in the risk-rating system. These
METHODS OF MORTGAGE RISK RATING Part I
221-222
features are, in turn, combined into larger groups described as
“categories. ” There are twenty-eight features grouped into four
categories, as follows:
The
Property
:
Structural Soundness
Resistance to Elements
Resistance to Use
Livability
and
Functional
Plan
Mechanical
and
Convenience
Equipment
Natural
Light
and
Ventilation
Architectural Attractiveness
Adjustment for Nonconformity
The
Location
:
Relative
Economic
Stability
Protection from Adverse Influences - Transportation Highways
- Transportation
- Adequacy of Transportation
Need
for
Housing
Appeal
Sufficiency
of
Utilities
and
Conveniences
Adequacy
of
Civic
,
Social
,
and
Commercial
Centers
Level of
Taxes
and
Special
Assessments
Topography and
Special
Hazards
The
Borrower
:
Reputation
Attitude
Toward
Obligations
Ability
to
Pay
Prospects
for
Future
Past Record
The Mortgage Pattern :
Ratio of Loan to Value
Ratio of Debt Service to Rental Value
Ratio of Life of Mortgage to Economic Life of Building
Lowest Category Rating Intermediate Category Rating
Highest Category Rating - Certain individual elements of risk are incapable of intelligent rating. For example, if an attempt is made to rate a property according to the number of baths, no satisfactory clue to rating is possible unless the Valuator relates the number of baths to the
requirements of the local market and the size of the house. However,
when he is asked to rate a factor such as “Livability and Functional
Plan”, he is able to form a very definite conclusion . Such a relation-
ship is ratable. The system does not rate the income of the borrower.
Instead, it rates the ability of the borrower to pay the debt service.
Part I UNDERWRITING MANUAL
222-227
That is, the judgment of the Mortgage Risk Examiner is applied to
the relationship existing between the borrower’s income and the debt
service of the contemplated mortgage. The selected twenty-eight
features or relationships are sufficiently different from each other so
that an intelligent independent judgment in connection with any one
of them can be formed. In the aggregate, the twenty-eight features
embrace all the most important ratable elements of risk in the making
of a mortgage loan on a dwelling property.- In the processing of an application for insurance,
each feature is given a rating which varies according to the extent
to which conditions regarding it contribute to the risk involved in
the mortgage project. Each risk feature is either an individual
risk factor or comprised of a number of correlated factors which can
be analyzed separately but treated as a unit. For example, the
feature “Sufficiency of Utilities and Conveniences” requires con-
sideration of the extent and adequacy of the pattern of street improve-
ments , public utilities, and municipal services. The resulting risk
contributed by the presence, absence, or grades of quality of any of
these things is reflected in the rating of the entire feature. - In each of the four categories of risk, the individual
feature ratings when combined comprise the rating of the category.
The Rating of Property is assigned by Architectural Inspectors and
Valuators. The Rating of Location is assigned by Valuators. The
Rating of Borrower is assigned by Mortgage Risk Examiners. The
Rating of Mortgage Pattern is assigned by Chief Underwriters. All
ratings are reviewed and finally established by Section Chiefs or
Chief Underwriters in accordance with jurisdictions and responsi
bilities outlined elsewhere in this Manual. - The ratings ascribed to the first three categories are
treated as three features in the Mortgage Pattern category and when
combined with three other features in the Mortgage Pattern category
result in the final risk-rating index of the mortgage. The final result
is referred to as the Rating of Mortgage Pattern . - The forms used by the underwriting staff contain
four rating grids, one for each of the four categories of risk . Each
grid lists the several features in a column at the left-hand side. Oppo-
site, on the right-hand side, are seven columns headed , respectively,
“Reject”, “1”, “2” , “3” , “4” , “5” , and “Rating.” The accompanying
illustration of a grid indicates the typical arrangement. - In rating the individual risk features, the risk-
rating system requires differentiation between six degrees of excellence
or poorness of conditions . First, differentiation must be made
between a condition that is so poor as to result in risk so great as to
warrant rejection of the insurance application . Above this margin
METHODS OF MORTGAGE RISK RATING Part I
227-229
below which a “Reject” rating of a feature is necessitated , differentia-
tion must be made between conditions ranging from “poor but accept-
able ” on up the scale of excellence through “fair” and “good” to
“excellent.” These designations are presented here simply to indicate
that the system recognizes that risk measurements are relative.
The terms themselves are not used on the forms because they would
convey implications beyond the simple idea of rating as suggested
by the use of the figures “1”, “2” , “3”, “4” , and “5”. Each feature
is rated by placing an X mark opposite it in the grid. Every
feature must be rated but not more than one such mark is made for
any one feature. A feature rating in the “Reject ” column indicates
that conditions relating to it are such that insurance of the mortgage
should be refused. A “1” column rating would indicate a very poor
condition just above the reject margin. A “5” column rating would
indicate that unusually excellent conditions pertain to the feature.
Intermediate ratings would cover the range in between.
228.
A
small
numeral
or “weight
“
appears
in
each
rating
column
after
each
feature
.
These
are
the weights
assigned
for
differ-
Rating of Borrower
Capacity Character
Reputation
Feature
Attitude
Toward
Obligations
Ability
to
pay
Future
Prospects
Past
Record
REJECT 1
2
3
4
RATING
10
15
20 25
14
12
16
20 ·
12 18 24 30
9 19
12 15
18
10
TOTAL RATING OF BORROWER
ent degrees of risk . When all X marks have been entered on the
grid, the indicated weights are copied in the right-hand column,
headed “Rating .” The sum of the weights carried over and placed
in the last column is entered at the lower right-hand corner of the grid
and becomes the total rating ascribed to the entire category. The
only exception is found in the Property grid. In it one feature weight
is deducted instead of added in securing the final Rating of Property. - The final rating for the mortgage is obtained by
recording ratings upon a grid known as “Rating of Mortgage Pattern. ”
On this grid there are several features involving the relationships
between certain features of the mortgage instrument, such as the
amount of the loan and the mortgage term in years, and matters
pertaining to the property, such as its estimated value and the esti-
mated remaining economic life of the building. Also listed as
features on this grid are the ratings of the several other risk categories.
Ratings on this grid are made for these last named features according
to the amount of the category ratings which have been previously
Part I UNDERWRITING MANUAL
229-232
determined. The sum of the ratings made on the Rating of Mort-
gage Pattern grid is the final index of the relative risk involved in the
mortgage project under analysis. - If the sum of the individual feature ratings in
any category is less than 50%, this indicates a degree of risk too
great to permit insurance of the mortgage. A large number of low
feature ratings will result in rejection of the application for insurance
because the resulting category rating will fall below the 50 % margin
of acceptability. The use of the percentages to describe degrees of
risk is apt to be misleading unless it is recognized that there is no
implication that the 50 % rating which constitutes the lower limit of
eligibility in a category represents “one-half” of the amount of risk
indicated when a category is rated at 100%. The range from 50%
to 100 % is intended to represent different degrees of risk above the
lower limit of acceptability. - The risk-rating system is so devised that after the
quality of the real estate security and the characteristics of the
borrower have been determined and found to be such that no undue
mortgage risk is created on their account, then by means of the system
it can be determined what is the maximum loan principal and maxi-
mum loan term in years which would represent the margin beyond
which economic soundness and, therefore, insurability would cease to
exist. Thus, after the ratings of Property, Location, and Borrower
have been made in a case, the Chief Underwriter in rating the Mort-
gage Pattern can determine whether or not the loan described in the
application is insurable, and if not insurable because the loan is too
large, or the term too long, or both, he can determine how large a loan
would be insurable and for what maximum term the loan could be
made. - Under the risk-rating system the determination of
economic soundness and eligibility of mortgages proceeds in four
steps as follows:
( 1 ) Determination as to whether mortgages submitted for
insurance are eligible or ineligible for further consideration, as indi-
cated by the application of eligibility tests based on certain provi-
sions in the National Housing Act, in the official administrative rules,
and in property standards.
(2) Determination as to whether mortgages accepted for
further consideration are insurable or non-insurable, by rating indi-
vidual risk features and ascertaining if any individual feature receives
a “Reject” rating.
(3) Determination as to whether mortgages receiving no indi-
vidual feature reject ratings are insurable or non-insurable, by rating
METHODS OF MORTGAGE RISK RATING Part I
232-236
risk categories and ascertaining if any category receives a rating of
less than 50%.
(4) Final determination of the degree of economic soundness
of mortgages receiving no individual feature reject ratings and no
category ratings under 50%, by means of a rating based on all feature
and category ratings. - It may be pointed out that the relative importance
of the several categories of risk differs from case to case. For example,
in a case in which either the Property, the Location, or the Borrower
Category receives a very low rating and the other two categories
receive relatively high ratings, the relative importance of the one
low-rated category in the over-all degree of risk is substantially
greater than in a case in which all three categories are rated alike.
For this reason the fourth category, namely, the Mortgage Pattern,
includes a device by means of which to take account of this relation-
ship. The category having the lowest rating is more heavily weighted
than the other two on the grid of the Mortgage Pattern. - The Mortgage Pattern is also so arranged that it
is possible to determine counter-proposals on a uniformly fair basis.
For illustration, consider a case in which the loan is too hazardous to
be acceptable for insurance because the amount of the loan is too
great. Analysis of the Mortgage Pattern, after the three other cate-
gories have been rated, makes it possible to determine how much of
a reduction in the amount of the loan is necessary to make it eligible
for insurance. - Detailed instructions in connection with the rating
of the twenty-eight features and four categories are presented in
Part II of this Manual.