Mortgage Qualification is About To Get Harder – Even More So Here in Illinois
30th May 2008
Over the last year mortgage qualification has become increasingly harder. Two new changes go into affect next week
which will ratchet loan approvals a little tighter still.
One is a change that only affects mortgages here in Illinois. Senate Bill 1167 will become law as of June 1st. This law is aimed at predatory lending and the problems caused by sub-prime loans. It restricts the types of loans available, requires home buyers counseling for home buyers in Cook County who are taking out specific types of loans, and it requires more transparency so the consumer knows exactly what they are getting when they enter into any mortgage financing. There are some good features in this bill, but most of what they are legislating against has already gone away due to market forces in the mortgage market. Sub-prime loans have been a big problem and there is no question that they were abused. But there is no such thing as a sub-prime mortgage now, so this bill is coming too late to make any real impact.
The one part of this that is going to hurt some is that stated income loans will no longer be available in Illinois. Stated income loans were loans which didn’t verify the borrower’s income, but took whatever was stated as the Gospel truth. As you can imagine, this was a license for abuse, and there were way too many borrowers who bought homes with no idea how they would pay for them. That said, stated income loans do make sense for well qualified borrowers with complicated tax returns – self employed borrowers. These loans, like so many others, have been disappearing over the last year. The guidelines in the law are somewhat vague as to what is considered stated income, but the lenders who were offering this program are taking the cautious path, and are withdrawing from the market. It looks like this will be the final nail in the coffin for any loans that don’t verify income, which means it will be harder for self employed borrowers to qualify for a mortgage.
The other big change is that Fannie Mae brings out their new version of their automated underwriting system, DU 7.0. Most conventional loans are approved through the automated underwriting system, so this will have a huge impact on how loans are approved. On the good side, this version does away with the declining market policy. Last December, in a reaction to the down turn in the housing market, Fannie Mae came up with a plan to identify markets where the prices were falling, and require a higher down payment in those areas. The plan basically made it harder to get financing in the areas that needed it most, and was not a popular move. So getting rid of this plan is a step in the right direction. It will be looked at as a bigger step if the mortgage insurance companies follow the lead and stop their declining market policies, too. The rest of the changes in version 7.0 are not going to be positives for mortgage borrowers. Some of the changes include:
- Borrowers must wait a longer time after a bankruptcy or foreclosure before they can get a mortgage again, and when they are ready they will need a higher down payment and a better credit score.
- Debt to income ratios, that is how much debt you are carrying, will be much lower.
- Condos will now be considered riskier, and harder to approve.
- Having mortgage insurance on your loan will not reduce the risk of having less than a 20% down payment.
- ARMs will be considered riskier than fixed rate loans.
There’s more, but the bottom line is that this is a way of tightening more, and some borrowers who will qualify for a loan today, may not next week.
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I think these are all accurate predictions – if oil keeps going higher – but if history is a guide, I think it will be a while before we see any of these predictions come off in a major way. Oil prices were around $90 per barrel at the beginning of the year, so we have had almost a 50% increase since then. The question is whether the prices will continue to climb and, how far will they go. My guess is that we will have higher gas prices long-term, but there are reasons to think that prices will come down some first, and that we will get used to higher prices.
economic stagnation. The Fed has been walking out on this tight rope, careful to not lean too far one way or the other. It’s been a difficult task and so far it looks like they are dipping on both sides, but still maintaining balance. The economy is slowing and inflation is heating up, but there are signs we are heading in the right direction.
mortgage bond markets and how the fear and greed balance out. On a day to day basis mortgage rates have been extremely volatile, and it has become almost commonplace for mortgage bonds to go up or down 40 tics in a day, an amount that used to be exceptional. There have been days when the market has moved as much as 100 tics, with multiple re-prices during the day. But if you pull back and look at the activity from a longer view, we are going back in forth in a fairly narrow range. This week the mortgage backed securities markets had two days where prices went up, a lot, two days where they went down about the same, and one day, Friday, where they moved around a lot, but ended with no change. There was a huge swing between the high for the week and the low, but at the end of the week we were very close to where we started. Over the last two months we have seen this same trend, though in a wider range. The market reacts (overreacts?) based on news reports and whatever happens that day seems to be the most important factor, until the next, possibly contradictory report is released the next day. Chances are that as long as the forces of inflation and the slowdown counteract each other, we will continue to stay in this range. What this means is that you should be aware of these trends if you are buying a home or refinancing your mortgage, and take these trends into account when locking your loan. 
Myanmar. With true disasters like this the mess in the real estate and mortgage markets doesn’t look nearly so bad. In fact, there were a few signs this week that we are starting to come out of the worst of the mess. While it is too soon to say that we have reached a bottom, there are signs that point to how we can navigate through this. We are still a long ways from where we were, but in a way we are coming to a new normal, and I see signs of the financial markets stabilizing and the mortgage industry gaining confidence. Two things happened this week that point to this conclusion. One, foreign investors started to show interest in buying mortgage bonds again, and two, Fannie Mae is getting rid of their disastrous declining market policy. 
A lot of economic reports were released this week, and as has been usual in this market, they were a mixed bag. Retail sales numbers dropped, but when low auto sales were factored out they increased by a higher than expected .5%. This could be looked at as proof that consumers are still spending, which means that the economy still has some strength. It could also be looked at as a reflection of higher prices, and the increase is due to inflation. Housing starts unexpectedly moved higher, but again this was a mixed result because the increase was due to a surge in multi unit apartment buildings. Single family home starts dropped for the 12th straight month. Consumer price index came in lower than expected, which means inflation is still manageable. Good news for mortgage rates. There were some other reports which showed that the economy is continuing to loose steam, and consumer confidence fell again to its lowest reading since 1980. 
one hand, the property values are down and you are able to buy a home at a bargain price compared to where homes were selling just a year or two ago. On the other hand, you wonder if we are near the bottom, or if the bargain you buy now will seem over priced a year from now. The truth is that markets (whether stock markets, bond markets or real estate markets) are unpredictable, and we won’t know where the bottom was until we have gone past it. That being said, I’m not sure we are at the bottom yet, but it is 
Now the pendulum has swung and we are on the fear side of the equation. At some point, probably when property values started to move down in the hottest markets, Wall Street saw the risk they were taking. They cut off the money spigot and since then mortgage underwriting has gone through a series of tightening measures so that it is harder to qualify for a loan now than it was before the whole loose money party started. With less people qualified for financing that means less people are able to buy. Lower demand means lower prices. So now fear has taken hold and everyone is looking at all the negatives. Foreclosures are up, the economy is soft and the inventory of homes for sale is the highest in years. Right now we are going through a cycle where the bad news in the market causes the lenders to pull back even more, reinforcing the bad news and making it that much harder for the market to recover. But markets are unpredictable and hard to time right. At some point the bad news will be less important than the opportunities for profit. In the stock market the recovery usually starts when people are the most pessimistic and it could work the same way in our market. By the time good news is out, we will have bounced off the bottom and prices will be heading up again. So the question is, is the time now? Are we close? 
and commodity prices are moving up sharply, too. At the same time in the real estate market few properties are selling, home prices are down and foreclosures are up. The economy is still shedding jobs, though at a slightly lower pace than before. Consumers are still piling on credit, but they are using more credit to buy gas and groceries. Not a good sign. We can see a lot of dark clouds on the horizon. So with all this bad news, is there a silver lining or, to mix metaphors, is the light at the end of the tunnel an oncoming train? We don’t know now and we probably won’t know for a while, but some on Wall Street think that the worst of the credit crunch is now over. But even if the big Wall Street players are starting to get confidence back, that won’t necessarily translate down to our streets for a while. 
Mortgage rates are now close to the lowest level in the last month. That means that many people who were sitting on the fence waiting for the right time to refinance, might have an opportunity to do it now. 
starting an addition to their current home or buying a vacation home. I’m still doing a fair amount of new purchases, but a lot of my calls now are about cash out refinances to consolidate debt. It always makes sense to make sure your mortgage is in line with your overall finances, but it is especially important when money is tight. A debt consolidation loan can help you to restructure your debt in a way that puts more money in your pocket and gives you a plan to actually pay down your debts. 
This plan has a lot of advantages, but you are increasing and extending your mortgage which can be a scary thing. Also, you need to have a plan on what you will do with the new savings. There can be a danger in this strategy. First, you are extending your mortgage and paying the loan over a longer period of time. You also need to watch how much the refinance costs. If you are paying too much for the refinance, it will be a long time before you see any benefits. But the biggest problem is that it is too easy to get back in the same trouble if you don’t change your credit habits. I’ve seen too many people who used a cash-out refinance to consolidate their debts and get a new start, only to run up their credit cards and get right back in debt. For a long term solution you need to be able to change your outlook and credit habits, too. On the other hand, if you take some of the money you saved and use it to start a monthly savings or retirement fund, or maybe shorten your mortgage so you are debt free years faster. What is best for you depends on your financial situation and your long and short term goals. Refinancing, if done properly, can be a tool to eliminate your debt and build wealth over time. Any time you take out a loan against the equity in your home you are trading some security for the cash you need, but if you have high balances on your credit cards it can be the right way to go.
I’ve written before, mortgage interest rates go up and down based on activity in the mortgage bond market. Mortgage bond traders are the financial market’s version of tea readers or fortune tellers. Collectively, they take in all the data as it is released, make split second judgments on how the data will affect the value of their investments over the long term and buy or sell the bonds based on their predictions. And they do this throughout the day, each day. A lot of money is riding on each decision, and the pressure to get the call right is enormous. This is especially true in our current market where volatility is so high. So as the information is released, all the traders make their decisions, usually assuming the worst. Later, it’s not uncommon that they look a little deeper and change their minds about the impact of the data. We saw great examples of that this week.
jobs each month, just to stay even. A loss of 20,000 jobs means we are 170,000 jobs worse than we need to be just to keep running in place. By the time lenders released rates in the morning, the loss was much lower, and at points in the day mortgage bonds traded in positive territory before ending with a moderate loss for the day. But this doesn’t tell the full story. The jobs report is the most anticipated report released each month, but it is almost never right. The report is based on a historical model, and much of it is compiled by assuming that the numbers will correspond to historical averages. This means that when the economy is growing the job gain is underreported, and when the economy is contracting job loss numbers look better than they really are. We are in a contraction now, and the previous reports have all been revised downward as the real numbers came in. So expect that these numbers will end up worse than reported, too.