The Mortgage Business: Back to the Past

OK, I admit it. I'm getting old. I have been in the mortgage business long enough to see things go full circle. Today the lending guidelines are similar to those of more than two decades ago when I first entered this industry. Loan approvals are once again based on sensible underwriting guidelines. No longer is everyone a candidate for home ownership as it has been for the past several years. There is no doubt that the system’s flaws of the recent past have been corrected. All of this change took place in the last 9 months and it’s incredible how quickly it has changed. It's about time. Just like fashion, it is interesting that trends come back around.

Today, like twenty years ago, the lenders are again using three things to determine eligibility for a loan; down payment, credit and income. While all three are important, more strength in one area can compensate for weakness in another. For example, if a client has good credit and an income that can be documented to support the house payment, a down payment may not be necessary. Or, if a client has marginal credit but a decent income and a large down payment, the lender may still offer a good loan. The third scenario is a client with good credit who is self employed or who has a source of income that is difficult to document. In that scenario, the lender may approve a loan, but require a higher down payment. The lenders’ current guidelines allow them to rest assured that the client can afford the home, has money at risk and is unlikely to make a payment late.

More on down payment guidelines. Lenders want borrowers to have their own money at risk. It has been proven over time that a client is less likely to walk from a home when they have some of their own hard-earned money invested in it. If a lender forecloses on a home and values have not changed, they will still be able to recoup approximately 80% of the original value of the home despite the cost of legal proceedings, missed payments, late fees, home rehabilitation and selling expenses. Considering that potential, a lender usually prefers a down payment of 20% of the sales price or requires the purchase of mortgage insurance that protects the lender from loss should they need to foreclose. Although 100% financing is available for the perfect situation, a down payment or equity in a home is almost always required. There is still money available for almost everyone, but only if you have enough invested to reduce the lenders risk of loss upon foreclosure.

Credit is equally as considerable to the underwriters. There are now several tiers of credit scores in which the interest rate is impacted. With a spotless payment record and adequate history of prudent borrowing, a client’s credit score will typically be in the 700s, giving the client access to the best money on the market. With just a few blemishes, the score may drop into the mid 600s, causing pricing and loan-to-value considerations to be negatively impacted. It is fascinating that just a few changes on a client’s credit file can make a significant difference in the score. Keep an eye on your score, if it drops below 700 and your payments have not been delinquent;; seek advice from a credit or mortgage professional to improve it. In certain situations, a higher score may be reached by simply shifting debt.

Income, of course, is a crucial factor. Lenders want to document that the client is generating enough income to make the house payment. Again, if the income is too low or can’t be documented, the lender will require a larger down payment to reduce its own risk. Often self-employed people can’t adequately document income due to their bookkeeping methods but still have enough income and cash flow to afford a home. In that situation, a stated income loan is most practical. A client will typically need to have been self-employed for two years or more and support that through business licenses or a letter from their CPA assuring the lender that self-employment has been disclosed to the IRS for at least the past two years. It must be a believable income for the profession to be considered. Again, the lender will want good credit and a down payment to offset the fact that the client cannot prove their income the way the lender wants.

No documentation loans are still available in some circumstances. Without being able to exhibit any income stream, a lender will still loan money as long as the client has invested at least 20% of the value of the home and is willing to pay an interest rate premium. These loans are only available with a good credit score that is typically 680 or greater.

Once it is established that a client is eligible for a loan, the property being secured becomes the final and sometimes deciding factor in the approval process. Many things are taken into consideration regarding the real estate being financed. For example, condos are restricted to lower loan-to-values (LTV) than single family homes by some lenders. Also, due to declining values in the valley and other areas of the country, some programs restrict the loan-to-value as well. A loan today at 80% LTV would not be at 80% LTV if the value were to drop, so the lender may require a larger down payment to protect against the potentially declining value of the asset.

So, just like 20 years ago, if a client can show financial strength and credit worthiness, there are excellent programs available to finance a home. The old adage holds true that if you can show you don't need to borrow money, the lender will most likely loan it to you. I am sure, however, that housing prices will increase again over time and lenders will revert to looser standards and allow anyone to borrow. The cycle will continue. Hopefully I will be retired by then.

Rod Dennis is the President of America’s Mortgage Store and can be reached at 480.850.6501.
To respond to this article, please email Rod@AmericasMortgageStore.com.