Mortgage Industry Changes Ahead

by Nancy Osborne, COO of ERATE

Consumers be prepared, dramatic changes in lending underwriting guidelines are coming. The markets are still experiencing the aftermath, and may not soon recover, from the tidal wave of risky loans which have closed over the past few years. The pendulum is about to swing in the other direction as investor money has all but dried up for sub-prime and so-called Alt-A loans and now many of these mortgage lenders have stopped making loans and have shut their doors. What comes next still remains to be seen but the days of providing 100% financing to borrowers with FICO scores below 620 are likely gone. As those borrowers who over-extended themselves, purchasing homes they simply could not afford with their lender's foolish blessing, experience their first rate adjustment and ensuing payment shock, the rate of mortgage defaults and foreclosures will rise. And as new tighter lending guidelines begin to take shape, many of these unfortunate borrowers will be prevented from refinancing. The supply and inventory of housing will continue to swell, effectively capping real estate values as the available pool of potential buyers shrinks along with their lending options and the balance between supply and demand tilts towards the supply side.

Stricter underwriting guidelines, or rather a return of sanity, will be the new standard of the day. Stretching guidelines to the point of qualifying anyone with the simple desire to own are over. First time buyers will find that lenders are no longer willing to push the boundaries of what is reasonable to get their loans approved. Adjustable rate loans will now be underwritten in line with standard industry guidelines of 2% over the initial start rate or qualified at the fully indexed rate (that is by adding the current index to the margin) and not at the initial start or teaser rate. New loan riders and disclosures may also be expected to add to the mountain of documents already signed by borrowers at closing. This will particularly be the case for those states having had in place looser consumer protection laws while the meltdown in sub-prime loans unfolded.

Your credit score has also played an important role in obtaining a loan, but now it will likely determine the rate you receive as well as the amount of the down payment you'll be required to make. The company that developed the FICO scoring system will now have an even greater pool of defaulting borrowers from which they can draw data and re-model their scoring system to filter out borrower risk. Note that the underlying purpose of the credit scoring system is to predict which borrowers are most likely to default on their payments.

Piggyback loans providing 100% financing were created to a large extent to eliminate a borrowers need to pay the dreaded PMI (or private mortgage insurance). Now it is likely that with a high percentage of these loans defaulting, the insurance protection was probably needed. Piggyback loans providing an 80% first and a 20% second mortgage may disappear. Down payments may increase for borrowers having credit scores below new higher limits and a lender approving a loan where a borrower has no equity stake in the property may be seen as nothing short of reckless. It is also to the benefit of a borrower to contribute something towards the down payment as it will likely expand the number of available loan options.

How you manage your non-mortgage debt will continue to be important because it will be reflected in your credit score. Therefore you want to continue paying your bills on time and keeping balances on revolving debt well below the maximum limits. Coming in and paying down debt at the 11th hour of qualifying for a loan is unlikely to help as it will have little impact on your credit score. Any surplus cash you are able to come up with would likely be better applied towards your down payment rather than paying down debts to in an attempt to reduce debt ratios.

Depending on the local conditions in your area, the impact on appraisals could be significant as property values trend lower. In some rapidly changing markets with many homes listed for sale, it is possible that the lender may request several appraisals. You need to exercise extreme caution when making an offer to purchase a property as valuations could become trickier. Back in the high flying real estate days of multiple offers, contingencies of almost any kind were taboo if you wanted any hope of having your offer accepted. However in today's market an appraisal contingency may offer you some well needed protection. If the home does not appraise at the agreed upon purchase price, the lender will base the loan on the lower of the two values. If you are unable to proceed with closing as a result of valuation problems, with an appraisal contingency in your contract at least the earnest money deposit you presented to the seller when you made your offer will be returned to you.

Based on the shockwaves in the financial markets created by risky lending, it is very likely the next move in rates could be downward. While the Fed does not directly control long term mortgage rates, they certainly exert an influence and they now need to ease fears of the mortgage lending calamity and resulting liquidity crisis from spreading into other areas of the economy. A changing interest rate environment could be on the horizon and while all the Feds previous moves have been upward, their next move may go quickly in the opposite direction.

  Nancy Osborne has had experience in the mortgage business for over 20 years and is a founder of both ERATE, where she is currently the COO and Progressive Capital Funding, where she served as President. She has held real estate licenses in several states and has received both the national Certified Mortgage Consultant and Certified Residential Mortgage Specialist designations. Ms. Osborne is also a primary contributing writer and content developer for ERATE.

"I am addicted to Bloomberg TV" says Nancy.