Lenders Tightened Credit

Banks Are Back To Basics

In 2004 to 2005, financial institutions were swamped with foreign funds. These caused them to lower their guards on mortgage requirements. Due to easy loans, many succumbed to home buying mania, which pushed prices to artificial record high. Then in 2007, the bubble busted- due to increased variable interest rates, and too high acquisition prices. And in addition to these, many were already high risk borrowers, even during the signing of contracts. Real estate moguls earned tons of money here; but what puzzles us is why these financial giants failed to anticipate and prevent this economic swing, with all the market indicators and their expensive think tanks. In 2007, an oversupply of homes led to steep drops in home values. The August 2008 Loan Performance Home Price Index (HPI) revealed that housing prices continue to descend (11.3 percent lower than a year ago) across the nation with very few exceptions, putting 18 percent of homeowners' mortgages "underwater."

Mortgage Bankers Association's (MBA) most recent mortgage lending survey reveals that borrowers are shifting (78.5 percent compared with 63.6 percent last year) strongly to fixed interest rate from variable interest rate due to tightening of lending standards. Mortgage refinance continues to be the lion share of mortgage originations at 61.7 percent. New home purchase financing dropped 16.2 percent compared to the second half of 2007. US mortgage applications dipped to 8 year lows. The other notable shift was a doubling of FHA and VA loans, from 5.7 percent last year to 11.8 percent now, which is attributed to the increasing of loan limits and some easing of lending standards for distressed borrowers.

Ever since Wall Street lost its appetite for mortgage securities, the supply of money for home buyers and refinancers has been tight. The biggest remaining investors are the federally chartered corporations Freddie Mac and Fannie Mae, which set the rules of the game and operate with the implicit promise that, if necessary, the U.S. government will step in to bail them out. That’s why, in mid July, it came as a shock to many investors that the mortgage giants’ solvency was questioned, which caused both to have downward spirals. Fannie traded at $ 40 at the close of 2007, and now just $ 9.73. During that same span of time, Freddie has fallen from $ $34 to $ 7.11. And to further aggravate the situation, Fannie and Freddie took the rest of the banking industry with them on July 14- as the selloff engulfed Citigroup (down 97 cents to $ 15.22), J.P. Morgan Chase (down $ 1.47 to $ 31.69), Bank of America (down $ 1.52 to $ 20.15) and Wachovia (down $ 1.70 to $ 9.84).

Three years ago it seemed anyone could get 100% financing on a half-million dollar home and lenders had a mortgage product for every situation. Today, lenders are back to basics, with more conventional mortgages.

Lenders now look for four chief things:

1. Does the borrower have sufficient income to repay the mortgage? For an FHA loan the borrower can't have debt that exceeds 44 % of their income – that includes their new mortgage payment. The proposed payment (including taxes and insurance) alone cannot exceed 33 % of income
2. How high is the borrower's credit score? Every loan program has different parameters, but basically the lender wants to see if the borrower could pay their bills on time.
3. Does the borrower have the down payment? Most major lenders require some money down on a mortgage.
4. What kind of collateral secures the mortgage? Basically lenders need to see that the home will appreciate rather than depreciate, which isn't always possible in these days of the credit crunch. Some lenders are requiring two appraisals.

These are the same criteria banks used for years before the real estate boom. FHA mortgages used them almost 80 years ago, when it started. These steps have stood the test of time.

How big should my down payment be? To buy a home, borrowers whose loans are processed by Fannie Mae's automated underwriting system can put down as little as 3 %. For other Fannie Mae loans and for loans from Freddie Mac, the minimum is 5 %. Borrowers who want to refinance and take cash out must have at least 10 % equity left once the loan is made. Down-payment or equity requirements may be higher depending on the lender and the private mortgage insurer (all loans with less than 20 % equity must have private mortgage insurance before they can be sold to Fannie or Freddie).

What's the outlook for interest rates? In the conforming-mortgage market, a 30-year fixed-rate mortgage in mid July averaged 6.4 % (plus 0.6 % in fees and points), compared with 6.7 % a year ago, according to Freddie Mac. The rate on 5/1 hybrid ARMs (the rate is fixed for the first five years and then adjusts annually) was 5.8 %, and one-year ARMs averaged 5.2 %. Rates will probably edge higher this year.

Written by Katherine M