Tightening the Screws

Unless you have to have been on sabbatical in Mongolia, you know that mortgage loan underwriting has been tightened since the great financial debacle a year ago. The government has placed Fannie Mae and Freddie Mac in a conservatorship and no one knows how or if ever those two entities will ever return to being public companies again.

Maintaining these companies’ viabilities is critical to returning the housing industry to whatever normal will mean in a couple of years. This is going to be a difficult task given that the cumulative losses at those companies has required about $100 billion of government financial support.  One has to wonder how those advances can ever be paid off.

One aspect of returning to health has meant assuring that any new loans that they buy or guarantee are good loans.  The first strictures were the elimination of stated income loans. Now all loans require strict documentation of income by paycheck stubs, tax returns, and so forth. Every borrower must also sign an IRS form 4506T which allows the lender to query the IRS so as to get data from previously filed returns. Will they check? You betcha!

The appraisal process has been modified substantially with the introduction earlier this year of new requirements that insist that all appraisals are ordered through Appraisal Management Companies.  This action was designed to prevent lenders and mortgage brokers from putting undue influence on appraisers to hit higher values. It is not clear that this was a problem but it does represent a change that is absolutely killing some deals.

In addition, the Private Mortgage Insurance companies who provide additional safeguards to the agencies have tightened their standards as well.  In California and other “risky” states, they will only write insurance on loans to 90 percent Loan-to-Value, not 95 percent, and borrowers must have at least 720 FICO scores.  The cost of PMI is also rising.

Under the banner of “fine-tuning its risk assessment,” additional tightening has been announced that will become effective on December 12, 2009.  If you are a potential borrower, you should understand what these changes are.

First, is a lowering of maximum allowable qualifying ratios. The Automated Underwriting models in force at each agency will now approve loans for otherwise high quality borrowers even though the ratio of the total financial obligations per month exceeded 50 percent.  That meant that a borrower with $4,000 per month gross income could still be approved even if his housing payment was $1,500 and his car payment was $500.

On the face of it, that was pretty liberal and, in my opinion, not suitable for a family of five. But I have seen instances where a single borrower could get along quite well. It also allowed a little leeway where there was additional household income, perhaps from a spouse who had income but whose credit was too poor to be included as a co-borrower.

The new maximum ratio will be 45 percent, with a possibility of 50 percent only in the case of borrowers with “strong compensating factors.” No one knows exactly what “strong” means.  The minimum credit score will be 620 although the pricing penalties for borrows with scores that low will still make such loans very pricy.

Borrowers who have had a foreclosure must wait at least five years before consideration and they must make a 10 percent down payment and have a minimum 689 FICO score.  Neither will such borrowers be allowed to do cash-out refinances until after seven years from the date of foreclosure.  Borrowers who give a home back to a lender by a Deed-in-Lieu of foreclosure will have similar restrictions for four years.  Borrowers who have filed for bankruptcy protection will face additional scrutiny.      

Non-liquid assets will suffer strictures as well.  Lenders will only be able to count 70 percent of investment account balances such as stocks, bonds, and mutual funds, presumably because in the event of liquidation, capital gains (you remember what those were, don’t you?) taxes might be due. Similarly, the values of assets in retirement accounts  such as IRAs and 401(k) accounts would be reduced to 60 percent of the account value.  If such funds were used for down payment of closing costs, verification of the actual liquidation by appropriate documentation will be required.

Advice: If this applies to you, do NOT wait until the last moment to sell the securities.

Finally, with respect to buyers of duplexes who intend to occupy one of the units will have to put at least 20% down and cash-out refinances of those properties will be limited to 75 percent Loan-to-Value.

Have a good day!