One major difference between the housing finance system today and the system that prevailed prior to the financial crisis is in loan underwriting — the set of rules and procedures governing who is approved for a loan and who is rejected. The swing has been from Lady Bountiful to Mr. Scrooge. Rules have been tightened across the board.
Where the major mistake before the crisis was approving loans to borrowers who should have been rejected, the major mistake today is rejecting loans that should be accepted.
The problem has been compounded by a cyclical swing in home appraisal bias. During the period of steady home-price increases before the crisis, appraisals tended to have an upward bias, which meant that they seldom derailed a transaction that was otherwise acceptable. Today, with home prices having declined sharply and with no price recovery yet in sight, appraisals have a downward bias. Deals are not getting done because the property values are coming in too low.
Because appraisals become available late in the underwriting process, furthermore, many applications are rejected after the borrower has paid an appraisal fee and sometimes other fees as well.
Because of the heightened risk of rejection and the costs that go with it, potential borrowers need a quick way to determine whether or not their likelihood of rejection is high or low. In addition, if the likelihood of rejection is high, they need to know exactly where the problem is, and what they might do about it. A new page on my website does exactly that.
It divides underwriting rules into three broad requirements: (1) absence of recent bankruptcy and foreclosure; (2) acceptable combination of credit score and down payment; and (3) acceptable expense-to-income ratio.
Requirement 1: Absence of recent bankruptcy and foreclosure
If you have had a recent bankruptcy or foreclosure, you are not going to qualify for a mortgage. The system is quite rigid, and while it forgives, the forgiveness takes time. My program will tell you exactly how long it will take.
Requirement 2: Acceptable combination of down payment (equity) and credit score
Lenders want borrowers to make a significant down payment (equity in a refinance), and to have an acceptable credit score. The two are combined because the requirements for each depend on the other.
For example, on conforming loans that will be sold to Fannie Mae or Freddie Mac, the minimum down payment is 5 percent and the minimum credit score is 620. However, because mortgage insurance is not available at credit scores below 680, the minimum score at a down payment of 5 percent is 720, and at a credit score at 620, the minimum down payment is 20 percent.
While exceptions are sometimes possible when the applicant has impressive "compensating factors," borrowers should not assume they will qualify for one.
The program shows where the credit score and down payment entered by the user compares to requirements set by a) Fannie and Freddie on conforming loans, b) FHA on FHA-insured loans, and c) portfolio lenders on other (nonconforming) loans. Because the data entered by the user is unlikely to be exactly the same as the data entered by a lender, the program shows a user who qualifies how close he is to not qualifying, and it shows a user who doesn’t qualify how close he is to qualifying.
Requirement 3: Acceptable income relative to debt payments
Guidelines set by the agencies and lenders limit the ratio of required debt payments to gross income to 41-43 percent. Income is gross income that can be documented. Debt payments include the mortgage payment, property taxes and homeowners insurance on the mortgage at issue, plus payments on revolving credits and other debts that won’t be paid off within the next six months.
The program calculates the user’s ratio and compares it to the maximums on FHA, conforming and nonconforming loans. In cases where the user’s ratio exceeds a maximum, the program shows the debt payment reduction or the income increase required to meet the guidelines.
In contrast to down payment and credit score requirements, which are quite rigid, maximum expense ratios are not rigid. Underwriters may raise or lower the maximums, depending on other features of the transaction.
The new tool won’t underwrite you
The new tool is not a complete substitute for having your loan application underwritten by a lender. The major differences are:
1. The new tool uses the income you enter but does not ask you to document it. A lender will ask you to document income, as well as the assets needed for the down payment.
2. The new tool uses the credit score you enter, but the lender will use a score obtained from another source, which may be different. The difference is likely to be small but even a small difference can matter if the score you enter places you close to the rejection line.
3. As noted, underwriters have discretion to adjust maximum payment-to-income ratios to other features of the transaction.