By Richard T. Cirelli, President, CMPS
RTC Mortgage Corporation
I think we can all agree on two things…
1. The economy won’t recover without a recovery in housing and 2. Underwriting guidelines are too tight.
Much has been said about underwriting guidelines being too tight. Fed Chairman Ben Bernanke admitted it in his press conference last month. The majority of the U.S. senators said it in a letter to the U.S. House Committee on Financial Services in an effort to stop the proposed Qualified Residential Mortgage (QRM) bill that would make underwriting guidelines even tighter (there has been no ruling on QRM yet).
It’s been estimated that between 25% and 33% of the loans that are declined are “near misses” – people that fall just outside the guidelines but are otherwise qualified. Here are my thoughts on what’s wrong and how it can be improved without costing the government or the taxpayers more money. It’s my list of underwriting guidelines that are hindering the recovery and contributing to the continued slide in home prices
Before you read on, understand that I.m not advocating a return to the ridiculously loose days of no money down, no-income documentation, subprime loans. I’m suggesting some common sense ideas and tweaking of the existing guidelines that would enable more qualified people to buy and refinance their homes to help the economic recovery.
• Eliminate Loan Level Price Adjustments (LLPAs)
These are adjustments to the cost or rate of a loan according to certain risk factors. Fannie Mae and Freddie Mac created these additional cost factors shortly after the government’s seizure of the agencies in late 2008. The most common LLPAs are for credit score and equity but others may also apply. The problem is that the borrowers that are most marginally qualified have to pay the highest rate, thereby creating a handicap right from the start. It affects first-time homebuyers the most since they usually have the lowest down payments. It also affects homeowners that would like to refinance into a lower rate thereby making their home more affordable and the owner more likely to stay even if they have lost their equity. Instead, they may be forced into a higher rate simply because they had to increase their use of credit cards during a difficult period which lowered their credit scores while their equity diminished due to the economy.
• Prohibit Overlays
Overlays are restrictions or additional guidelines that some lenders impose that are stricter than the standard Fannie Mae/Freddie Mac guidelines. They often apply to the borrowers Debt-to-Income ratio thereby eliminating some borrowers that meet the industry guidelines but fall just outside of the guidelines of the particular lender that they unknowingly chose. Many lender-imposed overlays are seemingly minor adjustments, but collectively they prevent many potential homebuyers or refinancing homeowners from qualifying simply because they inadvertently chose a lender with an overlay that disqualified them. I’m in favor of requiring all lenders to offer the Fannie Mae/Freddie Mac guidelines without overlays.
• Loosen Condominium requirements
A condominium project with less than a 51% owner occupancy rate or with more than 15% of the homeowners delinquent in their HOA dues is disqualified from Fannie Mae and Freddie Mac financing. So, what happens when the project no longer meets the guidelines? It instantly prevents all potential buyers from buying, sellers from selling and existing homeowners from refinancing. That in turn forces the value lower for all units in the project. And, more unit owners are likely to walk rather than make their payments as they become increasingly further under water. There may be qualified investors willing to buy the backlog of inventory in many condo projects if they can finance them now and later re-sell them to someone that can obtain a mortgage. Wouldn’t it be better to have a project with 40-50% investors or 16% delinquency than one with 100% of the units unmarketable?
• Regulate or License the Underwriters
Does it seem strange that the underwriters charged with the responsibility of making the decision as to who qualifies do not need to be regulated or licensed? Mortgage Brokers have to be licensed and pass rigid state and federal exams and background checks. But those that are responsible for approving or denying a loan don’t. In my experience, the underwriters that have the least amount of experience or confidence will create the largest number of conditions when underwriting a loan. If the borrower can jump through enough hoops or provide enough documentation to compensate for an underwriter’s lack of ability, the loan might be approved. I’m sure all lenders have their own internal system for monitoring their underwriter’s performance but this most-important part of the process is not consistent. (Note-FHA underwriters do have to be licensed but Fannie Mae/Freddie Mac underwriters don’t).
• Extend emporary loan limits to 729,750 indefinitely
Congress temporarily increased the loan limits for certain high-priced markets such as Orange County from $417,000 to $729,750. While these temporary limits were extended last year, they are set to expire again and be reduced to $625,500 on September 30, 2011. While there are some jumbo lenders, their rates are higher than those offered with Fannie Mae/Freddie Mac eligible financing. Down payment requirements are usually higher too. Let’s keep the limits as they are until the housing market recovers.
• Allow Special Circumstance Refinances
Many responsible people lost a job or had a major hardship due to the economy and are now perhaps able to get back on their feet. Yet, these people may be prevented from qualifying for a mortgage for many years. I’d like to see some rules written to allow consideration for those who that had a temporary setback for reasons outside of their control.
• Permit Short Refinances Without layers of LLPAs
We have programs allowing underwater homeowners to refinance up to 125% of the value of their home if their loan is owned by Fannie Mae or Freddie Mac. But, most lenders have imposed an “overlay” that limits these refinances to just 105% or less. And, there are Loan Level Price Adjustments that drive up the rate or cost due to the owner’s lack of equity. Let’s allow these homeowners to take advantage of the program designed by the government to help them take advantage of lower interest rates and payments. And, prohibit the Overlays and LLPAs mentioned above. Wouldn’t a rate reduction from say 6% to 4.5% enable many homeowners to stay rather than add their home to the inventory of future foreclosures?
• Penalize Servicers for Taking Too Long for Loan Modifications and Short Sales
The biggest problem with Loan Mods and Short Sales is that they take too long. After waiting months and sometimes more than a year for the current servicer of a loan to approve a transaction, the buyer has given up and the seller is deeper in debt. And, the government pays a reward of $1,000 for a servicer to complete a transaction. Take away the reward and charge them a penalty for not completing or denying a request within a reasonable period of time. The reward certainly hasn’t been enough incentive to entice the servicer to complete the transaction. It will greatly speedup the process and reduce the number of homes and people in distress.
Remember the reason for the bank bailouts and the stimulus programs? It was to AVOID A FORECLOSURE CRISIS. Did the banks that were “too big to fail” use those funds to help avoid a foreclosure crisis? No. They used those funds to get richer – not to help the people. And the government continues to let them impose unnecessary restrictions on homebuyers and homeowners trying to refinance.
Along with jobs, housing is the key to an economic recovery. Home values must be stabilized and foreclosures must be avoided. Let’s lighten up on the unnecessary and mostly unregulated guidelines I mentioned. It won’t solve the entire problem but I think it would help millions of people without adding to this country’s deficit or the potentially growing inventory of foreclosed homes.
Richard T. Cirelli is a 35-year veteran of the mortgage industry. He is the owner of RTC Mortgage Corporation, a full-service mortgage company based in Laguna Beach. He is a Certified Mortgage Planning Specialist. RTC Mortgage offers all types of residential and commercial real estate financing. Contact him at 949.494.4701 or Rick@RTCmortgage.com. Visit www.rtcmortgage.com.