Home The Washington Diplomat February 2009

Banks Tighten Loan StandardsTo Lend Credibility to Tarnished Industry

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It’s hard to imagine that the presidential race and the housing crisis could have much in common, but they’ve both made history, albeit in very different ways.

The election made history by ushering in the country’s first black president. With the slumping residential real estate market, certain home loans are also now history — namely the subprime, no money down, little documentation packages that contributed to the bursting housing bubble in the first place.

The experts all agree. In recent years, many of the core aspects of a mortgage loan were negotiable:

How much a buyer needed to put down on a home, how much collateral or reserves were needed in thebank, how high a credit score had to be, and what kind of documentation a buyer needed to bring to the table.

But with the industry — banks, mortgage brokers, investment companies, the list goes on — turning a blind eye to unqualified buyers to keep the housing boom booming, resulting in its bust, those days are gone. Nowadays — and likely for the foreseeable future — buyers are finding themselves under closer scrutiny and greater financial obligation if they want to purchase their own piece of the American dream.

Kevin Michno, area manager of the mid-Atlantic division of PNC Mortgage LLC, said the company considers four key elements before lending to a homebuyer. “We first look at their income and their ability to repay, we look at how they’ve handled debt in the past, we look at the value of the property, and the last piece is how much cash they have to invest in the property,” Michno explained.

Like buyers, banks have come under tighter scrutiny in the wake of the housing crisis, and not all have emerged unscathed — or still intact for that matter. PNC is one of the major financial players in the historic banking reshuffling that has taken place recently. Some banks have survived, others have collapsed, while still others are taking this opportunity to buy up friends and rivals.

Pittsburgh-based PNC is acquiring National City Bank of Cleveland. Charlotte-based Bank of America, meanwhile, bought Countrywide Financial and is also adding Wall Street investment firm Merrill Lynch & Co. to its behemoth roster — together, the banks will make up one of the largest financial services companies in the nation, with more than 30 percent of U.S. deposits. Likewise, Wells Fargo — after a dispute with Citicorp — is taking over Wachovia, and JPMorgan Chase bailed out the ailing Bear Stearns, as well as Washington Mutual (WaMu). Talks are also continuing between Citigroup and Morgan Stanley about a deal to combine their brokerage operations.

Along with the banking overhauls have come thousands of layoffs and major executive changes. Smaller independent banks though that retained more conservative lending standards during the boom times are faring relatively well.

So what’s left in this crazy market for consumers? Cheaper real estate and great deals, say experts and bank lenders alike.

“The best time to buy is right now,” said Cindy Stackhouse, real estate broker and owner of Century 21 Stackhouse & Associates in Montclair, Va. “Before, the price was too high and first-time homebuyers couldn’t jump into the market. Now, it’s such an opportunity for them.”

Stackhouse said that although the market has always had its share of ups and downs, she has never seen anything like this in her 30 years of real estate. In Virginia, for instance, she pointed out that homes in Prince William and Fairfax counties are selling at unheard-of prices. “We can’t complain about affordable housing in Virginia right now. They’re there for anyone who wants to buy.”

The market is especially active in Prince William County, which currently has the highest number of foreclosures in the state. Two years ago, a typical four-bedroom, 2.5-bathroom home in Prince William sold for 0,000. Today, that house sells for 0,000.

Arthur “Art” Hernandez, a home mortgage consultant with PNC Mortgage, deals specifically with first-time homebuyers. “My business has been blowing up because of the opportunities with the housing market,” Hernandez said. “With foreclosures, one man’s loss is another man’s gain.”

Even current owners are finding the time ripe for refinancing thanks to declining interest rates. Freddie Mac, which surveys mortgage rates weekly, recently reported the interest rate at 5.10 percent — the lowest interest rate since Freddie Mac started surveying rates back in 1971.

This steep drop in interest rates has stimulated a great deal of activity not only among buyers, but a jump in refinancing home loans among existing owners. For instance, refinances accounted for nearly 70 percent of all mortgage application submitted in one week in early December, up from 49 percent the week before, according to the New York Times.

So is this still a good time to refinance? That depends on your situation. Charlie Vance, D.C. area manager for Wells Fargo Home Mortgage, says every situation is unique, and he encourages homeowners to talk with a reputable lender. One thing to consider is that refinancing comes with settlement costs, which may take time to absorb.

For example, say a homeowner refinances and manages to lower monthly payments by 0, but settlement costs came in around ,000. It would then take almost two years for the homeowner to “break even” with the refinance. Plus, not all owners are eligible because their mortgages exceed the value of their homes, many of which were overpriced during the boom times.

“You should know the size of your existing loan, have an idea of what your house is worth, and then have an idea of how long you think you’ll live in your home,” Vance said. “If you plan to sell the house in six months, it probably would not be worth it because you wouldn’t have the loan that long.”

And in any case, the new stringent loan requirements also extend to refinancing, so owners must qualify just the same as first-time buyers.

That’s essentially the key to home loans nowadays: qualification. The very term “subprime” literally means a sub-level borrower, i.e. someone with less-than-stellar credit history, financial reserves and ability to repay the loan. These are the loans that got everyone into such hot water.

“For the most part, subprime loans have disappeared,” said a local lender, who asked not to be identified. “The days of easy credit, no-documentation loans are over. I had a recent customer rejected because of bad credit, even though they could put down a 30 percent down payment. They have to find another lender.”

Today, most conventional loans require a 5 percent to 10 percent down payment, and although the rules for getting a loan have clearly changed, there are still a number of options available for qualified prospective buyers.

But first, a primer: All loans essentially boil down to either fixed interest rate or adjustable-rate mortgages.

Fixed-rate loans — including the 30-year mortgages that were the standard for so many years — appeal to homebuyers who want the safety net of a set interest rate and monthly payment for the life of the loan.

Adjustable-rate loans, as their name suggests, start with a rate that’s lower than the fixed-rate product and for a defined period of time, this rate stays low. The rate though is tied to that length of time — or arm — and the caveat that got many of today’s homeowners in trouble is that when the arm is up, the rate also adjusts itself by going up, oftentimes much higher than what the buyer started with.

These loans also used to come with the option of only paying off the interest — not any actual principle — getting homeowners into further debt when the arm expired and built-up principle was suddenly due.

In the end though, it all comes down to risk, and which loan homebuyers choose largely depends on how long they plan to keep the property. For example, a lower-interest arm still makes sense for someone who knows they will move out in a few years’ time before the arm expires, rather than taking on a higher interest rate that’s tied to a fixed 30-year mortgage on a house they don’t intend to keep.

“I ask people what makes them most comfortable,” PNC’s Michno said. “They may be planning to move in three years. I would never talk someone into a product they don’t want. It’s got to feel comfortable to them.”

That’s why it’s crucial to find a good lender who can explain all your options — because the days of buyers not knowing the exact terms of their loans are long gone.

“My best advice is to pick a reputable lender, know something about them, and find an experienced loan officer,” said Vance of Wells Fargo Home Mortgage. “You want to sit down and talk about options well before you ever buy a house. You can actually get approved for the loan before you buy the house. That way, you’re in a much stronger position when you sit down to write a contract.

“The perception is that there aren’t loans available,” he added. “If you have very poor credit, it’s probably very challenging. But you don’t have to have perfect credit. Lenders are going to look at your income, your credit, the assets you have, and the value of the property you’re buying.”

What helps are what real estate experts and lenders call “compensating factors,” which come in many forms: A homebuyer’s income may be strong, for instance, but they may have had a credit problem a year or two ago that was fixed, or a medical emergency that drained what was otherwise a stable income. Another compensating factor: A medical student who will soon earn a doctor’s income, but isn’t quite earning that salary yet.

These are all plausible explanations, and lenders are willing to listen. In fact, it’s up to the lender to consider all the variables about the homebuyer before approving a loan that goes to the underwriter, so it’s important to be up front with lenders about your particular situation.

“Share that information with your loan officer,” Vance said. “A good loan officer will paint a picture, put together a story about yourself to take to the underwriter, and you want those positive compensating factors. Underwriters don’t get to meet the borrower, so you want to choose a professionally experienced loan officer. That’s your best advantage.”

First-time homebuyers have a greater advantage and flexibility when it comes to qualifying for the most coveted home loans. The two best loans among these are backed by the government, specifically the Federal Housing Administration (FHA) and Veterans Affairs (VA).

A VA loan requires no money down and offers that rare 100 percent financing — a government benefit to people who have served in the military. An FHA loan — which is a loan from a private company that is insured by the Federal Housing Administration — is great for first-time buyers with less-than-perfect credit who are less able to afford out-of-pocket expenses.

“You have to invest 3.5 percent of the value of the property. So, for a 0,000 house, you would need ,500 down,” Vance explained.

That is still a much lower percentage than most conventional loans, which can require a down payment of anywhere from 10 percent to 20 percent on top of money for closing costs. FHA loans do charge an annual renewal mortgage insurance premium of 0.5 percent, and loan limits can be lower than most conventional loans.

To qualify for an FHA-backed loan, lenders look at three areas: credit, income and assets. If any of those three is weak, the other two must be strong.

So having ,000 (or any sizable sum) in the bank after buying a house is ideal. The flip side is that being wiped out by a home transaction is a red flag, and FHA won’t allow a homebuyer to become completely leveraged on the purchase of a home. After all, that’s essentially what led to the subprime and foreclosure mess.

Another type of loan that’s gaining popularity is renovation financing, a specialty of Wells Fargo. A renovation loan essentially allows homeowners to borrow against the future value of the home. Other benefits can include lower monthly payments and increased tax deductibility.

Although the credit crunch has squeezed spending on home repairs recently, this is expected to rebound, with renovation spending projected to increase at a nearly 4 percent inflation-adjusted compound annual rate over the next decade, according to a recent report by the Remodeling Futures Program of the Joint Center for Housing Studies at Harvard.

“The current slowdown in home sales means owners are staying in their homes longer, so this will change trends for home improvement projects,” said John Sway, vice president and program manager of national renovation lending for Wells Fargo, who noted: “Owners with older houses will be making improvements that can help them save money on their utility bills. Energy efficiency is at the top of the list.”

Another layer of financing is what’s called a gift. On both FHA and VA loans, homebuyers are allowed to receive a gift from a family member as part of the entire loan. Remember that 3.5 percent of the value of the property that a homebuyer must have for an FHA loan? All or part of that 3.5 percent may be gifted from someone else.

On a conventional loan, homebuyers typically must have 5 percent of the value of the transaction for a minimum of 90 days sitting in the bank — and it has to be their own money. Homebuyers may still receive a gift from an immediate family member as part of their down payment, but it would have to be over and above that 5 percent.

Therein lies the challenge on a conventional loan these days: Say you want to buy a 0,000 home. Five percent equals ,000 — that’s a lot of cash in these tough economic times.

Michno of PNC Mortgage said the company has developed a loan product today that can still mean no money down for homebuyers — but they have to meet certain criteria.

“The guidelines are such that you have to have certain income ratio, demonstrated good repayment of debt in the past, and the value of property has to be valued at what the asking price is,” Michno said.

In the end though, the specifics of the lending package you choose will be determined by you and the lender. “We all have similar products and where the separation comes between companies is how you counsel that customer,” Michno said. “We have a responsibility as a lender to evaluate that customer and help them choose the right product. Sometimes, that evaluation means you have to say no [to them].”

Michno’s best advice: Interview a bunch of realtors and select someone who understands the market. Then, do the same thing with finding a lender.

“If you have those two pieces, you have two people who are working on your behalf to make a good decision. Then, you buy within your means and you start to build your wealth. It’s a great time to buy.”

Stackhouse of Century 21 agrees. In the end, the biggest difference between today and yesterday is that people simply have to qualify for their loan.

“When the market began to slide and the foreclosures started happening, many of those loans were the 100 percent [financing] variety,” she said. “Having nothing in the transaction is not a good, solid basis for home ownership. You have to have something in the transaction. There’s no free lunch.”

About the Author

Christine Cub

Last Edited on July 9, 2014