HomeLink Magazine Summer 2017: Mortgage Lending
Gone are the Days
New Changes to Mortgage Lending Rules
By David High, Alpine Bank
Individuals looking to buy a home in Steamboat Springs are often exceptionally qualified. They have a high net worth, substantial income, and great history of home ownership and credit. They expect the lending process to be quick and easy. However, recent regulatory changes in lending mean I find myself having to educate borrowers on a number of fundamental changes.
Risk based lending: The world of consumer lending (as opposed to commercial lending), has changed dramatically over the decade since the Great Recession in 2008. Prior to the recession, mortgage lending was largely based on the overall risk a borrower represented. Overall risk means a borrower’s income, assets, credit and the property/collateral were looked at as a whole. If there was a deficiency in a borrower’s income, for example, but he or she had a large amount of cash in the bank, then the loan was considered an acceptable risk.
During this time, the risk model of lending provided opportunity for abuse. Documentation requirements were relaxed, and a borrower could easily get a loan with minimal frustration and paper work. What was previously known as a “stated income loan” was designed for self-employed borrowers with sizable down payments or equity in a property with complicated income. Once the abuse began, stated income loans were made available to anyone who had a job and up to 95% of the value of a property on purchases.
Along with these programs came many other “exotic” loans that virtually eliminated any need to verify income or assets, and primarily relied on a credit score and down payment. I recall sitting in my office in October 2009 and watching the secondary market implode as these exotic mortgages were no longer being purchased and investors became wise to the fraud and abuse in the system.
Rules based lending: The correction in the lending markets forced the government to intervene and come up with new rules. Gone are the days of looking at a borrower’s overall financial position. Lenders are now required to look at each piece of a borrower’s financial puzzle on its own merit. Credit, income, assets and collateral have to be viewed as individual components in a loan decision, and if any one of the components does not qualify based on the relative rules of that category, the loan cannot be approved.
Credit: Credit score requirements are constantly shifting. Not only do the minimum credit score requirements change, but so do the numbers of late payments a borrower can have. The allowable time elapsed after a short sale, bankruptcy or foreclosure is a moving target as well. Additionally, Fannie Mae/Freddie Mac, the Federal Housing Administration (FHA) and the Veteran’s Administration (VA) all have lending programs with their own changing sets of standards.
Income: Documenting income can be one of the greatest sources of frustration for borrowers. Generally, we see that the most qualified borrowers have a complicated financial structure. Underwriters have to be able to understand how income is earned, how it is paid, and eventually how our borrower receives it. This may sound simple; however, it is common for lenders to see hundreds of pages of business tax returns with multiple layers of corporate ownership and varying percentages of individual ownership. Lenders’ questions about structure, ownership and historical income are often misinterpreted as questioning a borrower’s ability to qualify, when the real purpose is simply to build a complete picture of earnings.
Assets: One of the greatest sources of frustration for lenders is when a self-employed borrower decides to use money from his or her business as the down payment for a primary or second home. When this happens, lenders have to figure out a way to determine whether that cash withdrawal will negatively impact the business. Current lending rules evolved to include tracking the source of down payment funds. This process is often very frustrating for borrowers as well; especially when they are 100 percent owners of a company.
Another challenge is to track the movement of money. It is common for a borrower to take money from an investment account and move it to a cash account. This process requires providing evidence of stock sales as well as account statements, additional steps many borrowers find vexing.
Collateral: The recession revealed many weaknesses in the lending process, and one scam involved appraisers. Appraisers were manipulated to create value and often were part of schemes to buy and sell homes at rapid rates and at values that could not be justified. This system was one that began with many flaws because appraisers were often engaged from other geographic areas and had no business appraising homes outside their usual markets. These practices ultimately led to issues of credibility. These issues have since been eliminated, and lenders are required to engage appraisers that are vetted and qualified. Appraising is now a highly regulated process whereby a lender cannot know the identity of the individual executing an appraisal.
As we look at our current real estate market, there are similarities to what happened leading up to the Great Recession. Similarities include a very active real estate market with speculative building at a high level, and several large development projects in the planning and approval process. I am often asked about the market and take comfort in knowing that the current lending decisions were made with real income, assets, credit and collateral verification. I am hopeful that with the current lending environment, any changes we see in the real estate market will not be the result of unsustainable lending practices, but instead be brought about by the free market forces of supply and demand.