More Cash Down In These 'Declining Markets'

Home buyers and sellers in the Washington area face a new challenge: Most of the region has been tagged a "declining market" by the powerful loan underwriters who review mortgage applications.

That means appraisals are receiving an extra dose of scrutiny, and lenders are asking some buyers to come up with more down-payment cash.

Such a broad-brush treatment of the diverse Washington market risks weakening prices in neighborhoods that, so far at least, have been holding their own.

In November, a "declining market" flag was enough to scuttle a $510,000 home purchase planned by Tony and Sarah Pierson, both Army captains. They were only days away from closing on a brick Cape Cod near the historic district in Leesburg. But the deal fell apart when their lender, USAA First Mortgage Origination, notified them that, because of that flag, USAA would no longer honor its preapproval commitment for a package of first and second mortgages covering 100 percent of the price.

Even though the appraisal showed a value higher than the Piersons had agreed to pay for the home, USAA told them it would approve the deal only if the couple came up with a 5 percent down payment. "Five percent of half a million dollars is $25,000," Tony noted. They had that in savings, but had been planning to use it to renovate the house. They didn't close the mortgage.

The Cape Cod sold within days to another buyer, and the sellers refunded the Piersons' earnest-money deposit. USAA reimbursed the Piersons $750 for the loan application fees and appraisal. But the couple still had to scramble for a place to live, having already given up their rental. They incurred moving expenses. The Piersons feel frustrated about the experience. "They're cutting well-qualified buyers," Tony said.

This is just the latest repercussion from the breakdown in the machine that turns ordinary home mortgages into complicated mortgage-backed securities that are sold to investors. During the real estate boom, that machine turned a lot of bad loans into bad bonds. Losses from those investments have led to the current credit crisis.

Today, everyone from highflying bond investors to rank-and-file loan officers wants more assurance that new loans won't add to the junk heap. Everyone is trying to protect against tomorrow's decline in home values, whether or not such declines actually occur. Because they're afraid to lend money today, they could be engineering the very price declines they fear.

Declining market flags are popping up on the automated underwriting system used by Fannie Mae, one of the most influential companies in the mortgage bond-making business. The District company buys mortgages of up to $417,000 from lenders and repackages them for sale as mortgage-backed bonds. But before agreeing to buy a loan, Fannie runs the application through an automated underwriting system to evaluate the risks, including the borrower's credit rating and the home's appraised value. It's during that computerized underwriting review that the loan can acquire a declining market flag.

According to a Fannie Mae policy statement released last month, its declining market flag calls for a lender to more closely examine whether the home's appraisal accurately reflects current market conditions. It also requires that borrowers who would otherwise have qualified for a loan with less than 20 percent down bump up their down payment by 5 percent. It doesn't affect borrowers making a down payment of 20 percent or more.

Fannie is hugely influential in setting mortgage standards. If a giant such as Fannie says values are headed down, what other mortgage investor is going to be so bold as to dismiss the warning?

"It's not just Fannie Mae, it's every investor," said David Stevens, president of affiliated businesses, including mortgage lending, at Long & Foster Real Estate. As a result, according to Stevens, a loan that used to require 5 percent down now requires 10 percent, and one that required 10 percent now calls for 15. "It's stopping sales," he said. Officials at Fannie Mae declined to comment on my request for confirmation of a list of Washington-area communities that it flags as declining markets.