Getting a home loan just got harder

Getting a home loan just got harder
As some lenders collapse under the weight of bad mortgages, others are getting pickier. Now you have to have a real down payment -- and actually be able to afford the house
By Marilyn Lewis
With the news full of stories about the collapse of lenders that sell mortgages to people with less-than-perfect credit, the survivors are clamping down, leaving first-time home buyers to wonder, "Will I still be able to buy a house?" People with loans nearing the end of low-interest introductory periods are asking themselves, "Can I qualify for a refinance I can afford?"
The short answer, of course, is that it depends.
"The prime people will still be able to get loans. You'll just have to have a down payment, documentation and a higher credit rating, (although) I think there will be even some tightening in the prime," says Christopher Cagan, director of research and analytics for First American Real Estate Solutions in Santa Ana, Calif.
"It's the marginal people going for the sub-prime, low-doc loans who'll feel the change," he says. "They're going to be asked, 'Where's your documentation? Let me check that appraisal. What's your income?' "
In a nutshell, here's what the changes are likely to mean to you:
With a FICO score roughly above 620 and a stable income, you're likely to be a "prime" customer, although factors like other debt you're carrying and how much you want to borrow also enter the equation. Experts differ on whether they expect lenders to get fussier in evaluating customers for prime loans. Most say that with a strong record of paying bills on time, a documented, steady income and a loan request no bigger than 80% of the value of a property, you should be able to borrow easily and at a low rate. In fact, if you are in the prime category, now is a great time to refinance, since 30-year fixed rates are dropping to 6%, says Mike Fratantoni, senior economist with the Mortgage Bankers Association.
If your FICO score is below 620, you may still get a loan, but it's likely to be an expensive sub-prime product.
The new environment Until early 2006, the overheated lending market was pumping out money. Brokers competed to sell mortgages, and, in many cities, incentives to sell stoked home prices into double-digit yearly appreciation. Loans covering 100% of a home's purchase price were not uncommon, with no down payment required. Borrowers, even with badly damaged credit, were breezing into lenders' offices and emerging with loans that sometimes even locked them into paying more than they earned.
Now, "it's back to the old-fashioned rules," Cagan says. With less money available, and with fewer buyers and a glut of houses for sale, lenders are requiring detailed application forms and documents detailing finances and income.
Cagan is predicting that 13% of the 8.37 million adjustable-rate mortgages sold from 2004 to 2006 will fall into foreclosure in the next six or seven years, and that certainly will be disastrous for the 1.1 million families involved. But he's adamant that "this will not break the economy."
Still, talks with regulators and mortgage finance experts reveal some major implications for homeowners in the changing lending climate.
The three primary changes are:
A sharp reduction in "no-doc" loans.
A big reduction in 100% financing.
The return to strict, traditional standards in qualifying borrowers.
Most change will be concentrated in the riskier sub-prime market. That affects borrowers who can't document a steady income or an income substantial enough to make payments on the loan they want. People whose bankruptcy was discharged fewer than four -- or even as long as seven -- years ago may have to wait awhile to borrow, experts say.
While interest rates are expected to rise, they'll rise higher on sub-prime loans. For some borrowers, the question won't be "Can I get a loan?" but "Can I get a big enough loan to buy the house I want?"
"Those higher rates are going to be fed through to borrowers immediately," says Fratantoni, the Mortgage Bankers Association economist. "Some portion of the sub-prime market will no longer be able to qualify for loans."
Sub-prime products won't completely disappear, says Dustin Hobbs, spokesman for the California Mortgage Bankers Association, but the range and availability are likely to shrink.
No-doc loans No-documentation or low-documentation loans will be considerably harder to find. "We are going to crack down on the use of these low-documentation products," says Sharon McHale, spokeswoman for Freddie Mac, the congressionally chartered nonprofit corporation that works to create housing affordability.
With no-doc and low-doc loans, lenders waived income documentation requirements, taking a borrowers' word for their income or not asking at all. Such "stated-income" loans are sometimes called "liars' loans," and no doubt plenty of borrowers did overstate their incomes. But stated-income loans are a godsend for self-employed people who have a good, if erratic, income or take a lot of tax deductions, creating a low net number on their income tax returns, the document lenders use to verify income.
"Lenders are going to be doing more to verify incomes as standards tighten," says Hobbs, of the California Mortgage Bankers Association.
100% loans Look for the return of the traditional down payment as it grows harder to find a 100% loan, particularly a sub-prime one. No-down loans "will still be an option for those with good credit but more difficult with imperfect credit," predicts Hobbs.
Nervous lenders are becoming acutely interested in ensuring that borrowers don't over commit. "You still are going to be able to buy (a home)," says Cagan, "but you will be expected to put something down."
Here's how the 100% financing has worked: Lenders sell borrowers two loans -- one, a mortgage for the bulk of the house cost, and another to cover the down payment. The big loan is a first lien on the house, the second takes a subordinate position in case of default, so it goes for a higher interest rate. The loan package is split into two because most lenders require borrowers to buy private mortgage insurance (PMI) -- to cover the payment in case you cannot -- on mortgage loans greater than 80% of the value of the house they're buying.
PMI may be a good idea, but it's expensive. If you borrow the full value of a $300,000 home at 7%, your monthly payment would be $1,995.91 in principal and interest, plus $260 monthly for mortgage insurance. But put in $60,000 cash from savings and your monthly payment drops to $1,596, with zero insurance. (Use this PMI calculator at the site of lender good mortgage.com to run your own numbers.)
Now, not only are lenders (slowly) concluding it was risky to have borrowers overloaded with debt, they are also seeing, in the recent tide of foreclosures, evidence that when homeowners have no own money tied up in a house, it's emotionally and financially easy for them to walk away. They "were homeowners, but they really weren't homeowners," says consumer attorney Ira Rheingold, executive director of the National Association of Consumer Advocates.
A return to tradition A down payment is a good idea for other reasons, too. By increasing the proportion you pay of the purchase price, you lower your loan-to-value ratio, one of the important metrics that lenders use to figure your interest rate.
Another important metric is your debt-to-income ratio. The less you borrow, the better your ratio. This calculator from the nonprofit Credit Counseling Foundation will give you an idea of where you stand and show you how different loan amounts affect your ratio.
A cash down payment "helps throughout the whole (loan) deal," says Hobbs. "The more commitment you show, the better terms you are going to get."
Mark Hicks, a San Jose, Calif., real estate agent and mortgage broker, says he is finding 100% financing, particularly in the sub-prime market, is hard to get. "A lot of first-time buyers, that's how they got their homes," Hicks says. "Usually, it was important (because) a lot of them couldn't qualify. They had good credit scores but couldn't qualify on the income."
Taxes and insurance The return to traditional loan requirements includes ending the practice of removing taxes and insurance from the payment for which a borrower qualifies, says McHale at Freddie Mac. In recent years, some lenders qualified borrowers based just on their ability to cover the monthly mortgage payment. Now, be prepared to demonstrate that you can make not just the monthly mortgage but the entire ball of wax, including taxes and insurance.
For example, to qualify for a 30-year loan of $120,000 at 5.875%, your income must support an $896 monthly payment, including taxes and insurance. But if the taxes and insurance are removed from the formula, you could squeak into the same loan with a smaller income, since the payment would appear to be only $709, although you'd still have to pay the $187 in taxes and insurance each month.
Qualifying standards are tightening If Freddie Mac can help it, purchasers of adjustable-rate loans with cheap introductory periods will have to qualify on the basis of the higher, "fully amortized" interest rate, not the cheap introductory rate.
"We will not buy loans that are underwritten to the teaser rate," says Freddie Mac's McHale. "They have to be fully amortized rate."
That means if you got a loan with an introductory period at 5% that adjusts to 12% after two years, you'll be evaluated on your ability to pay off the loan at the 12% rate, not 5%, as before. For example, if you're borrowing $200,000, you'll have to qualify on the basis of the 12% rate, for a monthly payment of $2,057 (plus taxes and insurance), rather than the 5% rate, with a $1,073 monthly payment -- a difference of $984 a month. (Use the MSN Money mortgage calculator to punch in your own numbers.)
Sub-prime borrowers should prepare to pay at least 1 percentage point more than prime and probably considerably more, says Hobbs of the California Mortgage Brokers.
What to do The key to a new mortgage is to make conservative decisions. Here are five steps you can take to protect yourself as the housing market changes.
If you can't make your mortgage payments, call your lender, says Rheingold, of the National Association of Consumer Advocates. It is not in a bank's best interest to foreclose on your home, so there's an incentive to try to help you by reducing your payment and restructuring your loan.
If you're shopping for a loan, get the safest, most economical product, the 30-year, fixed-rate mortgage, Rheingold advises. Newer 40- and 50-year loans cost too much, and ARMs are risky, and growing riskier, with mortgage rates rising for many borrowers.
Don't buy any loan that you do not thoroughly understand. "If you were buying a used car and you saw some things that were a little bit the matter with it and you didn't understand, would you buy it anyway?" asks Rheingold.
Wait to buy and save for a down payment. House prices could easily go down in many markets, so put off your purchase if you can. Sock your money away so you can get score better terms from the lender when you do buy.
If you do buy, scale back your expectations and buy a less-expensive house. Even if a lender lets you, don't break your personal bank trying to get into a house you really can't afford.
Published March 20, 2007