When you were in high school, did your parents ever caution you about the company you keep? The people you share common interests with can be either a positive or a negative influence on your decision making. They can lead to to success, or they can lead you astray.
When lenders want to evaluate a potential borrower, they don’t interview friends, but they do examine the financial characteristics of a borrower’s life, and they make determinations based on the historical behavior of others with the same characteristics. That’s the whole point of a FICO score. The Fair Isaac Corporation built a successful business around classifying and categorizing large groups of people based on similar financial characteristics. If people in your group default at higher rates than other groups, your FICO score will suffer, irregardless of whether or not you think or act like those people. It’s not possible for credit underwriters to look into your heart or determine whether or not you have upstanding morals. They aren’t interested in you as an individual. They can only go by what others with your financial characteristics have done.
Drawing lines in the shades of gray
In any group of potential borrowers, there are some that will default, and there are some that won’t. Despite default rates north of 50%, there are still some subprime borrowers dutifully paying their mortgages. Should we bring back subprime lending because the 40% who would make it are currently being denied access to a mortgage?
The job of credit underwriters and actuaries is to properly classify people into the appropriate groups, then draw a line across the shades of gray. For the sake of bank solvency, this line will always be drawn conservatively. Obviously a 50% or greater default rate experienced in subprime is far too high, but what is an acceptable rate of mortgage default? FICO scores between 640 and 620 default about 15% of the time. The GSEs cut off in this range, and it can be argued that a 15% default rate is much too high and perhaps the GSEs should tighten further.
But even if only 15% of borrowers with FICOs between 640 and 620 default, that means that 85% do not. If the FICO score requirement is raised to 640, then 85% of creditworthy borrowers will be denied credit. Although the ratio drops with FICO scores, no matter how low you go, some creditworthy borrowers will always be denied credit. That’s the price they pay for the company they keep.
By Jody Shenn – Aug 22, 2012 10:13 AM PT
Fannie Mae, the largest source of money for U.S mortgages, told lenders that it’s tightening some of its qualification standards for people buying homes or refinancing loans.
The changes include a reduction of the maximum loan-to- value ratios for some adjustable-rate mortgages to 90 percent, from as much as 97 percent, and an increase in required credit scores for certain loans, the Washington-based company said yesterday on its website. Fannie Mae also will start demanding more tax returns from self-employed borrowers, according to Matt Hackett, underwriting manager at New York lender Equity Now Inc.
That one is going to cause problems for many consultants coming out of the recession. The self-employed will need to wait an additional year to prove the recession is over and their income is secure.
“This can knock a decent portion of borrowers out of the picture who had a rough year in business two years ago,” Hackett said of the tax-information demand, tied to an update of its underwriting software used by originators. Two years of personal and business returns will be required to verify incomes, up from one year of personal returns. “You’d be surprised how much of an effect this has,” he said.
As Perspective pointed out yesterday in the comments, we can’t pity the self employed too much. “I have friends who run/own their own firms. Everyone of them is doing well, but can’t get a mortgage (the size they’d want) because their returns show they’re living on much lower income than they really are. They have the temerity to complain about this. So, I have to buy my meals, vacations and cars with after tax income (33% reduced) while you get to buy/finance all of that with pre-tax income, and then you have the nerve to complain about mortgage standards keeping you from buying your dream home?”
Tougher guidelines from Fannie Mae (FNMA), which along with smaller rival Freddie Mac guarantees mortgage-backed securities financing about two-thirds of new loans, may add to challenges for a housing market that’s showing signs of recovering after a six-year slump. Pacific Investment Management Co., manager of the world’s largest mutual fund, said in commentary yesterday that while “record-tight” credit standards are impeding real- estate sales, they “will not last forever.” …
Pimco is right about today’s standards not lasting, unfortunately. The idea that current standards are “record-tight” is complete bullshit. We have merely returned to the sound underwriting that existed prior to the housing bubble. Low money down, no-doc mortgages are not the birthright of every American. I don’t think we are done tightening yet because delinquency rates are still far too high.
Fannie Mae’s tightened standards include an increase of minimum credit scores for adjustable-rate mortgages not vetted by its Desktop Underwriter computer software. Scores will need to be at least 640, up from a previous minimum of 620, on a scale ranging from 300 to 850, according to the memo. It is also eliminating a policy that provided lenders the flexibility to accept scores 40 points below its normal requirements for specific products if borrowers had other strengths.
If 640 becomes an absolute minimum threshold, many more “creditworthy” borrowers will fail to make the grade.
Changes to its guidance on so-called underwriting exceptions also will eliminate the concept of a “benchmark” ratio between borrowers’ income and housing costs of 36 percent, according to the memo. Instead, 36 percent will be the “stated maximum,” though the ratio can be as high as 45 percent if the borrowers meet credit score or cash reserve thresholds.
A 36% stated maximum will be huge. The benchmark was widely ignored by lenders, but now they will have to pay attention to it. People with large student loans, car loans, and credit card debts will suddenly be unable to buy homes. This will knock out many potential first-time buyers.
The new approach “provides more transparent requirements with regard to how compensating factors must be applied,” Fannie Mae said.
The company will end its FannieNeighbors product that offered underwriting flexibility for borrowers in so-called underserved areas. The loans were part of a program that also offers the aid to low-income individuals or public safety, education, military and health-care professionals.
Borrowers without traditional credit will be limited to loans for one-unit homes that they plan to live in, and the company will no longer accept “exterior-only” property appraisals for mortgages run through its computer software.
Obviously, all of the above exceptions lead to high default rates, otherwise they wouldn’t be making these changes.
Fannie Mae is loosening some standards, according to the memo. The loan-to-value ratio allowed for some fixed-rate loans on two-unit properties will increase to 85 percent, from 80 percent. Down payment requirements also will fall for certain co-op loans, according to the document.
When will credit standards loosen up?
Many people believe that credit standards will get looser as soon as prices bottom out because lenders will have less risk. I don’t think that will be the case. Lenders will still be worried about buy-backs because most of them operate on an origination model. Lenders on an origination model need to see delinquency rates back to historically low levels. We are still a few years away from that. Expect to see tight credit standards for the foreseeable future.
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Proprietary Irvine Housing News home purchase analysis
$470,000 …….. Asking Price
$313,000 ………. Purchase Price
3/26/2002 ………. Purchase Date
$157,000 ………. Gross Gain (Loss)
($25,040) ………… Commissions and Costs at 8%
$131,960 ………. Net Gain (Loss)
50.2% ………. Gross Percent Change
42.2% ………. Net Percent Change
3.9% ………… Annual Appreciation
Cost of Home Ownership
$470,000 …….. Asking Price
$16,450 ………… 3.5% Down FHA Financing
3.53% …………. Mortgage Interest Rate
30 ……………… Number of Years
$453,550 …….. Mortgage
$129,027 ………. Income Requirement
$2,044 ………… Monthly Mortgage Payment
$407 ………… Property Tax at 1.04%
$67 ………… Mello Roos & Special Taxes
$118 ………… Homeowners Insurance at 0.3%
$472 ………… Private Mortgage Insurance
$225 ………… Homeowners Association Fees
$3,333 ………. Monthly Cash Outlays
($305) ………. Tax Savings
($710) ………. Equity Hidden in Payment
$19 ………….. Lost Income to Down Payment
$79 ………….. Maintenance and Replacement Reserves
$2,416 ………. Monthly Cost of Ownership
Cash Acquisition Demands
$6,200 ………… Furnishing and Move In at 1% + $1,500
$6,200 ………… Closing Costs at 1% + $1,500
$4,536 ………… Interest Points
$16,450 ………… Down Payment
$33,386 ………. Total Cash Costs
$37,000 ………. Emergency Cash Reserves
$70,386 ………. Total Savings Needed
The property above is available for sale on the MLS.Contact us for a comparative market analysis, a cost of ownership analysis, or information on how you can make an offer today!
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