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3.000% (3.001% APR) 30yrs
2.375% (2.381% APR) 15yrs
as of 10/19/21
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Mortgage Blog

Why Many Good Mortgage Loans Are Not Being Made

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.

 

A third factor has been the post-crisis tightening of underwriting standards
imposed by law and regulation. The riskier mortgage types that experienced the
highest default rates are no longer permitted. This includes loans that allow
negative amortization where the payment does not cover the interest, and loans
that allow interest-only where the payment convers only the interest.
Monthly payments today must be fully-amortizing, meaning that if continued
through the life of the loan, the balance will be paid off at term.

In addition, riskier loan features that are still allowed carry a larger penalty
than they did before the crisis. For example, a borrower refinancing with
"cash-out" is subject to a larger price penalty relative to a no-cash refinance
than before the crisis, and may also be subject to a higher credit score
requirement, a higher equity requirement or both. The same is true of loans on
2-4 family properties and condos, relative to loans on single-family
homes.

But the tightening of underwriting rules following the crisis has gone beyond these
rational adjustments to a riskier environment. It also included knee-jerk
responses to pre-crisis abuses, particularly to the many cases of loans granted
to people who obviously couldn't repay them. A system of hastily enacted rules
and procedures designed to prevent this from happening again are now blocking
many good loans from being made. The following are major features of this
system:

A belief that all mortgage loans should be affordable. In fact, there are numerous
circumstances in which an unaffordable loan is in the interest of a borrower,
and where the evidence is compelling that the loan will be fully repaid. One
example is a cash-out refinance by an owner who wants to remain in the house a
few more years before selling, and uses the cash to make the payment.
Underwriter judgments are needed in such cases, however, and these are not a
part of the new system.

Underwriter discretion is substantially narrowed. Rules have largely eliminated
discretion, and the major role of underwriters today is to check for conformity
with the rules.

Ratios of debt-to-income above 43% indicate over-commitment by the applicant. Given
the wide range of circumstances that can affect a borrower's capacity to meet
obligations, fixation on any ratio as a maximum makes no sense. But again, the
sense should be provided by an underwriter with the discretion to make a call,
and that no longer exists.

The affordability requirement is absolute and not affected by the applicant's
credit score or equity in the property. Applicants making a
down payment of 40% with a credit score of 800 are turned down if their income
is not adequate. This makes no sense.

Income must be fully documented. Prior to the crisis,
documentation requirements ranged from full-doc to no-doc, with three or four
partial-docs in-between. The less complete the documentation, the higher the
price and the larger the required equity and credit score. That sensible system
is now gone and all loans must be fully documented. This is why I keep getting
letters from self-employed applicants who cannot qualify despite having large
equity and a high credit score.

Much of the system of rules and beliefs described above stem from Dodd-Frank, and
were formulated in an atmosphere hostile to lenders. But borrowers are the ones
paying the price.

The issues need to be reconsidered in an atmosphere free of vindictiveness toward
lenders. It could begin with Fannie Mae, Freddie Mac, and their supervisor the
Federal Housing Finance Agency, which could re-examine their rules, identify
those that should be liberalized, and determine which they could fix on their
own and which would require new legislation.

 

 

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