More Hoops for Borrowers
Home Buyers Face Growing Scrutiny as Lenders Tighten Standards, Look Beyond Credit Scores

By Dina ElBoghdady
Washington Post Staff Writer
Saturday, December 29, 2007

If you hope to get a mortgage this coming year, look beyond your credit score, because that's what lenders will be doing.

The mortgage mess that has grabbed the attention of politicians, economists and investors has also altered the loan options available to borrowers. Mortgages that require no down payment or no verification of income or assets have fallen out of favor. So have mortgages that exceed $417,000, also known as jumbo loans. It's still possible to find all those types of loans, but count on paying higher rates and jumping through more hoops.

When homes prices were rising, the borrower's credit score was pretty much all that mattered to lenders. Back then, homeowners could quickly build equity. That made it easier for them to sell or refinance their homes if they were strapped for cash, which insulated lenders from defaults. "So the credit score trumped everything," said Keith Gumbinger, a vice president at research firm HSH Associates.

But income matters now, and so does cash, said Sean O'Boyle, a vice president at SunTrust Mortgage in Chevy Chase. Lenders expect borrowers to have several months' worth of mortgage payments in reserve and a steady job.

"Job stability. Credit. Cash," O'Boyle said. "They're all equally important. Not one of them overshadows the other."

Lenders expect borrowers to put money down now, the norm being about 5 percent, said John Ulzheimer, president of consumer education for Credit.com, a personal-finance Web site.

While a few loans may require just 1 percent to 3 percent down, "lenders in those cases are looking for immediate equity in the property, meaning the appraisal has to come out at or greater than the amount of money being borrowed," Ulzheimer said.

For instance, if a home is appraised at $170,000 and sells for $160,000, the buyer has an instant $10,000 in equity, from the lender's perspective.

The more conservative lending environment has also meant a partial return to traditional underwriting ratios. Those were formulas dictating that your monthly mortgage payment, including taxes and insurance, should not exceed 28 percent of your gross pay, and that all your loans, mortgage included, should not exceed 36 percent.

"I called it hurdle underwriting," said Margie Hoffberg, president of Residential Mortgage Center, a Rockville mortgage brokerage. "The idea was that a third of your check went to taxes, a third to housing and a third would be left for everything else. We'd start with that, and if you could not get past that hurdle, we could not do your loan. It didn't matter what your income or credit score was."

Flexibility at a Price

But some flexibility remains. "There's no hard and fast rules about the ratios," said Jean Marie Pace, a loan officer at FNMC, a division of National City Bank. "If your credit scores are high and your monthly debt is low compared to your income, the ratios matter less. If that's not the case, the ratios matter more."

You can even find loans that require no down payment or no proof of income. Just expect tradeoffs.

"A lender might give you 100 percent financing, but they'll demand that you have a tremendous credit score," said Gumbinger of HSH Associates. "They might give you a loan that requires no documentation of income, but they'll require that you have a 20 percent down payment to offset the risk they're taking."

The requirements are being tightened for those who are buying a condominium, too. Fannie Mae, the largest investor in U.S. mortgages, now requires that lenders take a closer look at the condo developments, as well as at the borrowers.

For lenders who want to sell loans to Fannie Mae, that increasingly means filling out questionnaires that review the number of renters at a condo development, the concentration of investors there, any pending lawsuits and other factors that can affect marketability.

Fannie Mae has always required the questionnaire, but it generally accepted less extensive reviews for many borrowers, said Eric D. Gates, a mortgage broker at Apex Home Loans in Bethesda. The company is now limiting the shorter reviews to borrowers who have at least 10 percent equity.

Lenders who want to work with Fannie Mae and its rival, Freddie Mac, must conform to their rules. More lenders are doing so because Wall Street investors perceive these so-called conforming loans as a much safer bet than nonconforming loans.

In the nonconforming category are most loans made to subprime borrowers, who are generally defined as people with low credit scores. The scores that define subprime vary from lender to lender but traditionally have hovered around 620 on the most common scale, known as a FICO score, named after Fair Isaac Corp., a credit-rating agency.

Other factors that can knock people out of the more creditworthy "prime" category are past bankruptcy filings or foreclosures, as well as an inability or unwillingness to document income or assets.

When subprime borrowers can get a loan, it's generally been at a higher rate. But they will be hard-pressed to find any loan these days. With this year's jump in defaults, many investors stopped buying subprime loans, and funding for them dried up.

Mortgage bankers funded $177 billion in subprime loans in the first nine months of 2007, about $29 billion of it in the third quarter. That's down 66 percent from $522 billion in the first nine months of 2006, according to the trade publication National Mortgage News.

Enter the FHA

With subprime loans disappearing, the Federal Housing Administration has stepped in to fill the void for borrowers trying to refinance the loans they already have.

Most of these subprime borrowers have adjustable-rate mortgages, which started with low introductory rates that could later rise sharply. The most troublesome of those loans were the ones that originated in 2005 and 2006 and were due to adjust two to three years later.

As higher rates kicked in, large numbers of borrowers started missing payments, which is why the Bush administration announced the FHA Secure program in late August.

In September, the program started offering subprime borrowers who were late in their payments the option of refinancing into FHA-insured loans -- but only if they had made payments on time for six months before their loans reset to higher rates, and if their mortgages reset between June 2005 and December 2009. Previously, the FHA did not insure loans for late borrowers.

The FHA does not make loans; it provides mortgage insurance to borrowers through a network of private lenders. Those lenders will consider only borrowers who have at least 3 percent equity in their homes and who can verify their incomes.

About 141,000 borrowers have applied to the new program, said Steve O'Halloran, an FHA spokesman. The agency has approved 45,000 of those applications and is on target to help a quarter of a million families refinance by the end of 2008.

The administration and some of the nation's largest lenders also proposed a plan recently to temporarily freeze interest rates for some at-risk adjustable-loan borrowers. Countrywide Financial, the nation's largest mortgage lender, had previously said it hoped to refinance or modify $16 billion in mortgage loans held by about 82,000 borrowers.

Aside from these refinancing plans, the House and Senate have approved legislation that would lower the down-payment requirements on FHA-insured loans. The legislation would also raise the limit on the size of loans the FHA can insure from $362,000 to $417,000 in states with high home prices. The two chambers must now reconcile their versions of the measure before sending it to the White House for the president's signature.

"We think this bill can help 200,000 more people refinance," O'Halloran said.

Rarely does the FHA offer insurance for adjustable loans. "We back the 30-year, fixed-rate, garden-variety, plain-vanilla mortgage," FHA Commissioner Brian Montgomery recently said.

Adjustable Loans Still Exist

But the adjustable-rate mortgages that have been so closely linked with foreclosures are still widely available and can be a good fit for some borrowers, said Gumbinger of HSH Associates.

Adjustable loans generally carry lower interest rates than fixed-rate loans written at the same time. That makes them suitable for someone who plans to move before the rate adjusts.

These loans may also be the only choice for people who need jumbo loans, the ones exceeding $417,000.

Jumbo loans are not nearly as risky for lenders as subprime loans, but they are classified as nonconforming because Fannie Mae and Freddie Mac are prohibited from buying them. When investors yanked their money out of the nonconforming market, some firms specializing in jumbo loans shut down, stopped making those loans or got more selective. Many reacted by simply raising their rates.

That has led to a widening gap in the cost of jumbo and conforming loans in recent months, making the former more expensive.

Lenders were charging an average 7.02 percent interest for prime 30-year, fixed-rate jumbo loans last week, compared with 6.20 percent for conforming loans, according to HSH Associates.

That rate may not be exorbitant by historical standards. "But it may be more than your budget will allow," Gumbinger said. "So you may want to consider an adjustable loan," such as one with a fixed rate for five years that adjusts each year thereafter. This so-called 5/1 adjustable loan could give borrowers a break of half a percentage point or more from the 30-year, fixed-rate loan. But if you get an adjustable-rate loan, stay tuned to market conditions to see if an opportunity to refinance comes along, Gumbinger advised.

Before deciding on an adjustable loan, shop around, Gumbinger said. These 5/1 loans are available from plenty of what are called portfolio lenders -- lenders that plan to keep the mortgages rather than sell them to investors.

But there's a wide range of pricing in a given marketplace -- from less than 6 percent to more than 8 percent on 5/1 jumbo adjustable loans at one point this month. It all depends on what kind of loan the lender is interested in having in its portfolio at a given time.

"Some lenders are actively pushing to get business in their door," Gumbinger said. "Others prefer to be less aggressive."