Ten years ago, so-called ‘no-doc’ mortgages were all the rage. Fast forward a decade and home lenders are now demanding ‘every doc.’
I’m going on the record at the outset here to declare that the latter is preferable to the former. But there has to be a middle ground. If the stringent lending standards adopted in the wake of the financial crisis five years ago aren’t relaxed a bit, the onerous requirements will continue to act as a drag on the housing market.
The ‘no-doc’ mortgage, which allowed countless borrowers who had no business getting a loan to purchase houses they couldn’t afford, in some respects represented the first domino to fall in the housing market collapse that nearly toppled to the global economy. When those borrowers started defaulting on their loans in droves it wasn’t long before all hell broke loose.
In 2002, I quit my job in New York and moved to Rhode Island to write a book. I used $100,000 from the proceeds from an apartment I sold in Brooklyn as a down payment and was quickly approved for a $160,000 mortgage on a home in beautiful Bristol, R.I.
After signing a handful of papers promising to pay the money back, I distinctly remember the mortgage broker noting that I didn’t currently have a job. “But you’re gonna get one, right?” he asked. “Sure,” I replied. (I did and we paid the mortgage on time every month.)
Three years later when we sold the house to return to the New York-area the situation was a little different. The house had increased in value by about $100,000, which was good for us. But the market was already starting to cool off so it took a few months to find a buyer.
The Pendulum Has Swung
When we did I was relieved but more than a little confused. The guy buying our house was in his mid-20s, lived at home with his parents and worked a seasonal job. Nevertheless, through the miracle of ‘no-doc’ and zero down payment loans, he got his mortgage. I learned later that he defaulted within 18 months.
Now the pendulum has swung 180-degrees.
When applying for a mortgage these days every single penny of income must be accounted for. And if the lender views any money involved in the purchase transaction as a one-time occurrence – a gift or a loan from a family member, for instance – the borrower needs to prove to the lender that there will be no gaps in future income.
Income from part-time jobs that provides extra money to cover the bills or a vacation or the note on a new car is often dismissed by mortgage lenders because these jobs may be sporadic – painting a few houses on the side, a few nights bartending here and there, a freelance gig copy-editing textbooks, that sort of thing.
That won’t fly with many lenders. The only income they will count against the mortgage is from a job held for more than 12 months with no breaks of 30 or more days. And forget it if your second job is paid in cash. Lenders want W-2s.
Self-employed workers and those such as waiters who derive a significant portion of their income in cash should keep scrupulous payment records if they’re planning on applying for a mortgage anytime soon. There is no such thing as a ‘stated-income’ mortgage any more. Lenders are no longer taking borrowers’ word for it.
Low credit scores are also disqualifying thousands of would-be homeowners. A study last fall by housing research firm Zillow of 13 million loan quotes and more than 225,000 purchase loan requests plugged into Zillow’s web site found that applicants with a credit score below 620 were unlikely to receive a single quote from a lender.
Nearly one in three Americans has a credit score below 620, according to Zillow. That’s not really surprising. A credit score can be adversely affected by something as small as forgetting to pay a credit card bill on time.
Help May Be on the Way
Apparently pregnancy might even be cause for rejecting a mortgage application because lenders fear the mother may eventually decide to quit her job and stay home to raise the child, slashing income needed to repay that mortgage.
Ironically, help for borrowers being squeezed out of the housing market by arduous restrictions may be on the way in the form of higher mortgage rates.
Rates are expected to tick higher in 2014 -- possibly back toward the 5% range -- in the wake of the Federal Reserve’s decision in December to start gradually scaling back its monthly purchases of mortgage-backed securities, a policy initiated after the 2008 housing crash and designed specifically to keep long-term interest rates low.
“The silver lining to rising interest rates is that getting a loan will be easier. Rising rates means lenders’ refinance business will dwindle, forcing them to compete for buyers by potentially loosening their lending standards,” said Erin Lantz, Zillow’s director of mortgages.
To reiterate, all of this makes sense when looking back on the egregiously lax lending practices that helped inflate the housing bubble last decade. Besides, lenders really don’t have much choice but to thoroughly cross their t’s and dot their i’s.
That’s because now it’s much more difficult for lenders to get home loans insured and guaranteed by the government entities -- the Federal Housing Administration, or Fannie Mae and Freddie Mac -- that traditionally back-stop housing loans. If borrowers default and the FHA or Fannie and Freddie determine the lender was careless in making the loan, the lender could be forced to buy back the loan from the government.
So if you haven’t applied for a mortgage in the past 10 years and are thinking about buying a new home, be prepared for a stressful, drawn-out process.