Tuesday, June 8, 2010

Just When You Thought It Was Safe to Go Back in the Water

With the homebuyer tax credit ending at the end of this month, and the summer home buying season kicking off, many home buyers are looking to take advantage of lower housing prices and historically low interest rates. But many unsuspecting borrowers are going to get caught in new, even stricter underwriting guidelines being implemented by Fannie Mae starting June 1.

According to Fannie Mae's FAQ's posted on May 28,2010, the new Loan Quality Initiative is necessary because "in recent months we have seen a large portion of Fannie Mae's postpurchase file reviews with material differences between the loan data delivered to us and the actual facts of the loan (differences caused by data mismatch, calculation errors or other inaccuracies)."

Of course, in reality Fannie Mae is still dealing with losses from 2005, 2006 and 2007, and both Fannie Mae and Freddie Mac are bleeding red ink. As of May 25, 2010, Fannie and Freddie had received $145 billion in aid from the U.S. Treasury, and Edward De Marco, acting director of the Federal Housing Finance Agency, gave a report to Congress that more funds are needed in order to shore up the entities.

To prevent additional losses, Fannie Mae seems to be now placing the emphasis on guaranteeing fewer loans. The Loan Quality Initiative is a new overlay of scrutiny being applied to Fannie Mae loans to verify that no new debt has been acquired from the time of application to the time of the closing.

Back when I started in lending 12 years ago, discrepancies between the broker's credit report and the lender's credit report used to be a major source of problems. The broker would pull a trimerge credit report (one that accesses three credit reporting agencies) and think everything was fine, and then the lender would pull their own report which often looked quite different, and the entire loan would change. But with the advent of automated underwriting systems, the broker could pull a report, upload it to the automated system, and the credit report was valid for up to 90 days (at one time it was 120 days) so that no new pulls were necessary and everybody knew what credit score was being used for qualification.

Unfortunately, now we are regressing back to the old days of two credit reports. According to the Fannie Mae FAQ's, "The lender is responsible for implementing practices to identify undisclosed liabilities in a transaction. It is the lender's responsibility to develop and implement its own business processes to support compliance with Fannie Mae's requirements on loans delivered to us. Although many lenders already have such processes in place, Fannie Mae provides lender tips on efanniemae.com for compliance." Fannie Mae's suggestions for compliance with the loan quality initiative include the following:

1. Pulling a new credit report just before closing and reviewing the report for additional trade lines and new inquiries. (Fannie Mae states in a footnote that credit reports are still good for 90 days and that pulling a credit report just before closing does not let the lender off the hook for any additional debt incurred up to closing.) However, if the lender chooses to pull a new credit report, they must qualify the buyer with any new debt that appears on the report.

2. Utilizing new vendor services for borrower credit report monitoring from the time of loan application to closing to alert the lender if any new inquiries have occurred. For example, if Ted and Jane go out over the weekend to Furniture Mart to look at bedroom suites for their new home, and they allow Furniture Mart to do a credit check, the lender is going to need to know about it, and the inquiry will trigger a request for more information.

3. Direct creditor verification. If Ted and Jane get that credit check at Furniture Mart, the lender needs to verify with Furniture Mart directly that no additional credit has been opened. If the lender finds out that they actually purchased the bedroom suite over the weekend, then Ted and Jane now need to qualify with the new payment.

4. Running a report to verify that the borrower has not taken out another mortgage simultaneously. This would normally be an issue only with an investor who is purchasing multiple properties. When he closes the mortgage on one of the properties, it would trigger an alert.

The new system of verifications is going to give a whole new meaning to the phrase "buyer beware." In the new world of tightened credit guidelines, Fannie Mae typically does not allow debt to income ratios of over 45%, although ratios of up to 50% can be acceptable with enough reserves. For loans with mortgage insurance or second liens, debt to income ratios typically cannot exceed 41%. Since reserve requirements can vary depending on the product--for example, a person who already owns a home which is going to become a rental needs six months of principal, interest, taxes and insurance to cover the payments on the previous home and the new home, and since retirement accounts can no longer be used for reserves unless they have been liquidated, cash in the bank is more important than ever. For this reason, if the borrower who is having to wait 60 days for his loan approval has to take the car to the mechanic to get the brakes fixed, he would probably charge that work to his credit card after being warned by his loan originator not to spend any cash. But now, that brake job may still cost him the loan for his house, because it might raise his minimum monthly payment just enough to keep him from qualifying. (I have seen loans where ratios really are that tight.)

And even if the new debt is not sufficient to derail the loan, inquiries and higher balances on credit reports can lower credit scores. Since 30 year fixed interest rates are now based on credit scores, lowering a score one point could raise the interest rate .5%. Interest rates are based on 20 point credit score intervals, so a credit score of 660-680 has a higher interest rate than a credit score of 680-700. If the borrower has a 681 score at the time of the initial application, and he is locked in at a 4.99% rate, but then the final credit score in the second report is 679, his rate could go up to 5.25%. (And the higher monthly payment on the mortgage could keep him from qualifying.)

Buyers need to be counseled carefully at the time of application and at the time of contract to not use their credit cards at all, and to not apply for any new credit, no matter how tempting the offer. With new strict guidelines governing nearly every aspect of the mortgage loan process, the underwriting and closing turn times are longer than in the past. The new guidelines from Fannie Mae mean that at the very least, a final credit check can trigger a file going back to underwriting which can delay the process another week and result in a ready to close file being declined at the eleventh hour, or the borrower closing on a final loan which has less favorable terms than the one for which they were initally approved. And, in an era of supposedly protecting the consumer, that is the real irony of all of the new changes.

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