A Chill Comes Over Credit

· Minimum FICO credit scores are up by 30 to 50 points, depending on other characteristics of the transaction.

· Borrowers are being qualified for adjustable-rate mortgages using the fully indexed rate, which is the most likely rate at the first adjustment, rather than at the discounted initial rate. Regulators have been pressing for this, but the market is doing it voluntarily.

The tightening of underwriting requirements has not been limited to the subprime sector. The requirements in the "Alternative-A" sector, which is an intermediate classification between prime and subprime, are also being tightened. And so are the requirements for "prime."

Some loans that would have been prime last year will go Alt-A this year. Some loans that would have been Alt-A last year will be subprime this year. And some loans that would have been subprime last year will be rejected this year.

Some brokers who have been in the market for many years remarked that the underwriting rules now emerging are much like those of a decade earlier, before they were swept away by the euphoria created by steadily rising real estate prices. The emerging new rules, which are not based on the inevitability of rising prices, are a badly needed corrective.

Unfortunately, the transition to more restrictive underwriting rules poses a danger to borrowers and a costly nuisance to brokers. A borrower can begin the process under one set of rules and then have the rules change before the deal is done. Here is a recent example from my mailbox:

"In January, my husband and I decided to build a home. . . . The mortgage company prequalified us for a subprime loan. . . . They said as long as we had a 580 middle [credit] score by closing, we would not have to have any down payment. A week ago the mortgage company called and said the conditions had changed and now we have to have a 620 or better to close, or else come up with 5-10 percent down. Can they do this to us?"

Borrowers can avoid such costly disappointments by applying the following underwriting rule to themselves: Under the rules now emerging, if you can't put 5 percent down, have a FICO score of less than 620 and can't document the income needed to make the payment on a fixed-rate mortgage, you will probably be rejected. Homeownership is not for everyone.

Jack Guttentag is professor of finance emeritus at the Wharton School of the University of Pennsylvania. He can be contacted through his Web site,http://www.mtgprofessor.com.

© 2007, Jack Guttentag

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