Mortgage Blog

The housing sector today is not providing the economic stimulus we had come to
expect during periods of economic recovery. A major reason is that the
underwriting rules and practices that determine whether or not an applicant
qualifies for a home mortgage are much stricter today than they were before the
financial crisis.

In part, the tightening reflects changes in the market environment that make
mortgage loans generally more risky than they were before the crisis. The major
factor was the nationwide decline in house prices between 2006 and 2009, the
first such decline since the 1930s. The very liberal terms that prevailed prior
to the crisis were based on a widespread belief that such declines were a thing
of the past. When price changes are always positive, it is very difficult to make
a bad mortgage loan. Now that the market understands that house prices can
decline, mortgages are considered riskier.

A second factor has been the post-crisis practice of Fannie Mae and Freddie Mac
to require lenders originating loans for sale to the agencies to buy them back
if they default too quickly. This has caused many lenders to impose
underwriting rules (referred to as "overlays") that are more restrictive than
required by law and regulation.

It is not an academic question. My calculations show that the wrong choice can cost as much as $33,000 over 15 years on a $200,000 loan, and as much as $66,000 on a
$400,000 loan.

Don't jump to the conclusion that the better choice is the mortgage with the lower interest rate. FHAs carry a lower interest rate but largely because of their high
insurance premiums, they usually (but not always) cost the borrower more.

Do You Qualify For Both?

You have a choice between FHA and conventional mortgages only if you qualify for both. Then you can select the one that will cost you the least over the period you hold it, provided you correctly identify which one that is. Borrowers who cannot qualify for a conventional loan have no choice, they must use an FHA, which means that step 1 is to determine whether or not you qualify for both. If you can only put 3.5% down, for example, you can only qualify for an FHA, and the same is true if you can only put 5% down and your credit score is less than 660.

Because qualification requirements can vary with the purpose of the loan and type of property, there are a number of other situations where borrowers can only qualify for an FHA. If the borrower is looking to purchase a 4-family house, for example, qualification may be possible only with an FHA because the down payment requirement is much smaller
than it is on a conventional loan.

While FHA qualification requirements are generally less restrictive than conventional requirements, there is one important exception. Loans used to purchase a property for investment purposes, as opposed to occupancy, are not allowed by FHA under any circumstances.

Will That Help Consumers?

Markets for financial services often don't work well for consumers. The trial and error
technique that consumers rely on in navigating many markets, such as food and
clothing markets, does not work well when transactions are large and
infrequent. Financial firms who expect to see a customer only once may have
little incentive to provide good service. Because of the complexity of many
financial products, consumers often have less information about the products
than those who sell it. The new consumer complaint facility created by the
Consumer Financial Protection Bureau (CFPB) can be viewed as an attempt to
offset these factors so that financial markets will work better for consumers.

The "Submit a Complaint" Facility

The new facility is deployed on CFPB's web site, where consumers can lodge a complaint
against any financial service provider from whom they have obtained a loan,
lease or other financial service. The consumer registers the complaint with
CFPB, who forwards it to the service provider, who responds to CFPB, who
delivers the response to the consumer who accepts or disputes it.

CFPB records each complaint with the name of the firm involved, the product, the
consumer's state and zip code, the date the complaint was received, the date it
was sent to the firm, the firm's response and whether it was timely, and
whether the consumer disputed the firm's response. While similar complaint
programs exist at the state level, the CFPB program is unique in its use of the
internet as its principal communication device, and in developing a data base
of complaints that is available to the public. The data base includes a
filtering system that allows users to sort data into the specific categories
they want to examine.

The data base grows by the day and the growth will accelerate as consumers become
increasingly aware of the facility. On August 24 when I accessed it, there were
279,498 complaints about the following products or services: mortgages 116,
335, credit cards 38,536, debt collection 36,231, bank accounts or service
34,905, credit reporting 34,625, student loans 8,509, consumer loans 7,896, and
payday loans 2,339. (Yes, I know the components don't quite add to the total,
but write your complaint to CFPB).

"Can I get a mortgage with a credit score of 450?"

If you get one, it won't be a mortgage you want.

Credit scores are calculated using a variety of models that have small differences
between them and generate similar but not identical scores. The range of scores
in most models is 300 to 850, with a score below 620 considered sub-prime, and
a score of 450 marking the subject as a deadbeat who no honest lender will
touch. If you have equity in your home, however, there are some predators who
will lend to you in the expectation that when you default, they will find ways
to shift the equity to themselves. Don't bother asking me who they are.

"What should my target credit score be if I want the lowest possible interest rate on a
mortgage?"

It depends on where you start, and on how much time you have to raise your score.

If you begin with a 620 and have 18 months, shoot for a 660 which will drop the
rate by about .375% (say 4.625% to 4.25%). If you begin with 680 and have 18
months, shoot for 720 which will drop the rate by about .125%. Some lenders
will drop the rate by another .125% at 780, but you can't get there from 680 in
18 months.

Note that credit scores are calculated from mathematical models, of which there are
many designed for different types of users. Mortgage lenders won't ordinarily
use the same model as auto loan lenders, and some mortgage lenders use
different models than others. Different models will generate different scores,
and while the differences are small, your target score should include a margin
of error of at least 5 points. This would make the targets discussed above 665
and 725.

Consumers looking to purchase a home within the near future face many decisions,
including how large a down payment to make. The down payment is the sale price
(confirmed by an appraisal) less the loan amount. In most cases, home purchasers
must have financial assets at least as large as the down payment they make.

Down Payment as an Investment:  Many consumers put down as little as possible
despite having the capacity to put down more because they view the down payment
as lost money. But that is a mistake. The down payment is an investment that
yields a return that is far above anything else available to consumers, and the
return is 100% risk-free. Here is an example: