Wednesday, September 22, 2010

The Top Three Reasons Why It Is Hard to Get a Residential Loan

As we officially move into fall, underwriting is backed up as much as thirty days with homeowners who want to refinance and one or two who want to take advantage of historically low interest rates and the most affordable housing market the U.S. has seen in years.  But even for the "perfect" borrower, closing a loan still feels like running through mud. So, on hump day, I thought I would devote this post to three reasons why it is so hard to get those loans closed.

1.  Buybacks.  When a loan is sold to Fannie Mae or Freddie Mac, the lender's contracts obligate the lender to buy back the loan if the loan does not perform either due to fraud in the file or poor underwriting which does not meet the guidelines of Fannie and Freddie.  Both entities have been in conservatorship for the last two years and according to a report last week from Edward DeMarco, acting director of the Federal Housing Finance Agency, both enterprises have lost over $226 billion since 2007.  Of that amount, about $148 billion in losses has been borne by taxpayers and the balance was borne by shareholders of Fannie Mae and Freddie Mac prior to the government takeover of both entities in 2008.  To stem the tide of losses, Fannie and Freddie appear to be concentrating their primary efforts in two areas--forcing the lenders to buyback non-performing loans and requiring lenders to modify existing homeowners.  According to DeMarco, during 2009 lenders had to buy back $8.7 billion of single family mortgages and for the second quarter of 2010 lenders owe $11 billion to Fannie Mae and Freddie Mac in loans that need to be repurchased.  According to DeMarco one third of these repurchase requests are 90 days old, and "many of lenders with aged, outstanding repurchase requests are among the largest financial institutions in the United States...If these discussions do not yield reasonable outcomes soon, FHFA may look to its supervisory and conservatorship authorities provided under the statute to resolve the situation."

Fear of buybacks is a major reason that lenders refuse to sign off on good files.  Some very honest underwriters will admit that--they simply cannot afford to repurchase these loans. If they know that the government is going to be taking legal action against them to make them repurchase $11 billion in loans in a few months, they are going to look long and hard at the loan on their desk today to see if they think they will have to buy it back in the future.  That is also a key reason that an exception to underwriting guidelines is almost as difficult to come by as a presidential pardon.

2. No new products.  Demarco makes the point in his testimony on September 15 that Fannie and Freddie are focused on limiting risk exposure.  "Rather than developing and offering new products [Fannie Mae and Freddie Mac] must maintain their focus on mitigating credit losses and remediating internal operational weaknesses while employing prudent underwriting standards and guaranteeing proven mortgage products."  In other words, Fannie Mae and Freddie Mac will not be introducing any new products with more lax underwriting standards.  DeMarco states that  since the end of 2008 Fannie and Freddie have stopped buying Alt-A and interest only loans which he calls "two of the poorest performing mortgage products in the market."  DeMarco goes on to say that interest only loans purchased by Fannie and Freddie prior to 2008 have a delinquency rate higher than 18% and Alt-A, which were the stated income and reduced income documentation loans, have a delinquency rate of 12%.  .  With a track record that bad, we cannot expect to see these loan products return any time in the foreseeable future.

3. They only drink cream.  Years ago, a local mortgage banker said of his mortgage business here in El Paso, "I only drink cream."  I think those words could become the new motto for the government owned versions of Fannie and Freddie.  Consider these facts:  In 2006, credit scores below 620 made up 6% of Fannie Mae's portfolio--in 2010 loans with a credit score under 620 comprise less than 1%.  The average loan to value for a loan with Fannie Mae today is 69% and the average credit score is 758.  A credit score above 750 no longer makes a borrower special--that is the credit profile that the Fannie and Freddie expect to see, along with a low debt to income ratio and a steady source of consistent provable income.  And according to DeMarco, the insistence on purchasing higher quality loans is making a difference in the bottom line: "Due to the focus on improved purchase quality and underwriting standards, the loans that [Fannie and Freddie] purchased in 2009 and 2010 have had much lower rates of delinquency in their initial months of repayment than did mortgages originated between 2006 and 2008."  Unfortunately, if you are a borrower with a few dings on your credit or income problems, a conventional loan is not going to be the right product.  And that creates a real challenge, because while Fannie Mae and Freddie Mac are focused solely on avoiding risk and defaults, the housing market as a whole is suffering because buyers who don't fit into the narrow guidelines which these two mortgage giants have created are struggling to get financing.  And while FHA can make up some of the shortfall, it cannot make up for all of it.  In El Paso, Texas, the Fannie Mae conforming loan limit is $417,000.  The FHA loan limiting is $275, 000.  For borrowers who do not fit into Fannie Mae or Freddie Mac guidelines, they cannot borrow more than $275,000 for a home loan unless they can take advantage of VA or USDA.

The new plan to restructure housing finance and replace or restructure Fannie and Freddie will be released by the Treasury in January of 2011.  Until that time, we just have to be patient and hope that one day soon we will private market competition to provide options and solutions for frustrated home buyers.


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