Applying Common SenseAfter the financial turmoil of the past year or so, you would be easily forgiven for thinking that getting a mortgage for that new home will be difficult. Since everyone knows that the residential mortgage crisis started all this mess, it is a natural assumption to expect the market to be slammed shut for a while. Like many assumptions, that one is logical and wrong.

Before going any further, it should be pointed out at the start that mortgages aren’t going to be easy to come by for prospective borrowers who don’t have an income that will cover the monthly mortgage with a comfortable amount left to spare, and especially for those who can’t document their income. Borrowers with good credit records will have the most success, and for those with some weak credit history it’s still possible to get a loan but
it will cost more.

But for the average borrower, lenders of money are still looking for you. As with most economic slowdowns, the demand for loans has slowed considerably and banks find they suddenly have money to lend again. Since the interest rate spreads have grown to comfortable margins again, lenders can make better than average returns by giving you that mortgage. To connect with one of these anxious lenders, you’ll just need to know what the rules are today.

The vast majority of home mortgages are sold after origination. It is the buyers of those mortgages, the secondary market, that have been changing the rules. “The secondary market has tightened up their requirements significantly,” notes Del Hague, who heads up residential lending for Washington Federal Savings. “Their underwriting has become more conservative, but for the most part the changes are going back to what has been normal historically.”

Much of how the landscape has changed can be understood by just applying common sense. The vast majority of people who take out a mortgage pay it back. We’re talking about 95% historically. That’s because historically, lenders took limited risks before lending, and borrowers knew that they would have to prove their credit worthiness. The details will vary, but by and large those standards are where we have come back to in this current market. Don’t expect some third party broker to call you to offer an easy mortgage with no concern about affordability. The name of the game for bankers is once again: how will I get my money back?

SO WHAT CAN YOU EXPECT?

For starters, the easiest way to get credit is to have a good credit record to begin with. Keeping debt low, paying your bills on time and limiting (or eliminating) any revolving consumer credit will keep your credit rating high. Your credit score is often referred to as your FICO score, so named after a credit model developed by the Fair Investing Corp. During the go-go days of easy credit in the middle of the decade a FICO of 600, which represents weak credit, was the level that was targeted for the sub-prime mortgages that have been such a problem. Today, that score will get you turned down flat.

“Credit score has become very, very important,” agrees Del Hague. “The minimum for loan level price adjustments [which add provisions or costs that can make loans undesirable to the borrower] used to kick in at 700 or 720. Now the minimum is 740.” Hague points out that the borrower with the higher score is also going to get a better rate as well. His example of the 740 FICO score illustrates the fact that banks now want more money for higher risk. So the prospective borrower with weaker credit (and a lower score) can expect to pay a half percent or so higher interest rate on the loan, and probably an additional point for the closing.

The lender is going to want you to have more money of your own in the game. Down payments of 10% or more will be the norm. Premium mortgage insurance, or PMI, will be required for loans over 80% of the appraised value. This concept isn’t new, of course. The ‘American dream’ used to involve saving up money before you bought the house, and it does again. Aside from demonstrating that you can save money, the down payment or equity helps assure that you have an incentive to keep the
mortgage current.

“For our bank, it’s important that you have adequate equity, but also adequate liquidity reserves in place in case something happens to disrupt your income,” says Dollar Bank executive vice-president Andy Devonshire. Keeping the liquidity after the loan is Devonshire’s recommendation for maintaining financial strength. “Too many people recently added consumer debt after they got their mortgage, borrowing to pay for new furniture or cars. If they got laid off, or lost a second income, they had no reserve to help them keep making payments.”

Probably the single biggest culprit in the house of cards that was the mortgage industry a few years ago was the ‘no doc’ loan application. Without question this concept, that you could state your income without having to document it, defied all common sense. But since the people selling the mortgages, brokers like Countrywide or American Home, made their money by originating loans, not collecting on them, the documentation represented one more obstacle to getting a deal done. Those days are gone. Be prepared to have 30 days worth of pay stubs to verify your current rate of pay, and several years of current tax returns to show the lender the pattern. Don’t be surprised by questions about irregular patterns or significant changes in your income. The lender doesn’t really think you are hiding something, but he isn’t going to explain to his boss why he didn’t ask the
question later.

Of course, documenting your income isn’t the only requirement. Ratios for debt to income became more lax as the housing bubble built. While standards have tightened, the ratios you can expect are what have been historically required. Lenders will want the monthly mortgage payment to be no more than 28% of your income, and total debt not to exceed 36%. The expectation of constantly rising home values drove the ratios down, but those expectations have moderated in the past year.

Another breakdown in the system was in appraisals. In many parts of the country, where rapid appreciation had been experienced, sloppy or overly optimistic appraisals often left lenders with mortgages against overvalued homes. When the bubble burst, borrowers were faced with owing much more than the value of the home, which was a serious disincentive to continue making payments. Your bank will expect a well-documented appraisal for the home you’re buying. This part of the process may take more time than in recent years, and again, don’t be surprised if there are questions asked by the appraiser. A ‘drive by’ appraisal isn’t likely to happen today.

For the most part our appraisals have been coming in alright. We’ve only had a few houses not appraised high enough,” says Northwest Savings Bank vice-president Patrick Funwela. “In fact, we had more incidents early in the year where the appraiser was reluctant to submit the value because it seemed too high compared to all that everyone was hearing about the big decline.” Funwela noted that some of the appraisers Northwest uses are fairly conservative and they were worried when the normal methodology was producing results that were holding their value, even though most of the day-to-day business media was an endless stream of bad news.

One of the more frustrating byproducts of the systemic breakdown is that the closing will now be a bit longer and more tedious. Expect to see a few disclosures to sign. These will simply state that you, or the lender depending on the disclosure, have seen or shown everything you have been required to during the application and underwriting process, and that nothing was inaccurate or misleading. In almost every case, you will be signing a statement that discloses some detail that is included in a document that you have already signed, but expect to sign anyway. Part of this is covering the bases, but some of the disclosure requirements are meant to ensure that your lender (or you) didn’t forget to tell the other party something important. The increased paperwork will drive you a little crazy at the closing, but extra regulation always follows a financial industry breakdown so grin and bear it.

It’s an old saw about banking that a lender only wants to know three things before giving you a loan: How will you pay it back; if that fails, how will you pay it back; and if that fails how will you pay it back. Following a financial scare like the one experienced last fall, it’s not unexpected that credit has been a bit clogged. One year later it appears that common sense has returned to the mortgage market. That may mean a few more questions, but the answer for prepared and qualified borrowers will still be: yes. NH