Lending Guidelines Change – The Future of 100% Financing, Sub-prime, and First-Time Homebuyers

You have likely seen the television news reports or have read the newspaper and know something about the demise of the sub-prime mortgage business.

By now, you, or someone you know, thought they were getting a mortgage, and then suddenly, without warning, were turned down for that loan, because the bank no longer offered that program.

You may have even seen “The Mortgage Lender Implode-O-Meter” that many of my colleagues have sent me on the website mortgageimplode.com.

You also know that this is being caused primarily by a record number of foreclosures as well as the highest percentage of people who are late on their mortgage in nearly four years.

As a result, nearly every mortgage lender in the country has dramatically changed its lending guidelines in the last 30 days, especially the sub-prime banks that decided to stay in business.

Many banks have made the decision to close. According to the Implode-O-Meter, this number is now at 39 as of today.

New Century, the third largest sub-prime lender in the U.S, is no longer accepting loan applications. They are on the verge of bankruptcy or closure, depending on the reports you read. Their stock, which had been at 51 in the past year, hit a low below 4. It dropped nearly 70% in one day.

You have probably dealt with Fremont and Aurora as well. Fremont is the second-largest independent U.S. mortgage lender. They recently closed their sub-prime division.

Aurora recently eliminated a very popular sub-prime program they had.

You may have even had a deal fall out of escrow because of it. The buyer, who was a slam dunk loan a month ago, today can’t qualify.

Why are these guidelines changing like this and so rapidly?

The mortgage business works like a river with a downhill stream. All of the water ends up in the same pool at the end of the river.

Nearly all mortgage loans originated everywhere end up being purchased by a handful of companies. This handful of companies purchase nearly all of the mortgage notes made in the U.S. These are large, institutional, Wall Street investment companies.

These investment companies buy mortgage notes because they have been highly profitable in the past few years. They were profitable because the market was vibrant. People made their payments on time and when they didn’t, they simply sold their property at a profit before they lost the home to foreclosure. Mortgage notes were lucrative and came with little risk.

The rewards were tremendous and nearly every large Wall Street institution from Morgan Stanley to Lehman Brothers to Goldman Sachs to Credit Suisse got in the game. Even General Motors owns two mortgage companies.

However, with foreclosure rates higher than ever and late payments also very high, these mortgages are no longer profitable for these Wall Street investors. In fact, they have become an albatross threatening to bring them down.

Sure, it’s great to own a $60,000 Note on a second mortgage where a guy pays you 11.000%. However, when he goes into default and you take back his home and he is upside down by $100,000 and you lose your entire $60,000 because you are in second position to the first mortgage note holder, it’s a first-class beating.

Some experts say these investors now potentially could lose billions of dollars. General Motors announced this week they are writing a $1 billion check to cover losses in their mortgage division. That’s billion with a “B.”

The biggest loser for these Wall Street investors has been sub-prime mortgage notes and second mortgage notes. Their research shows that these losses are mostly and directly related to first-time homebuyers and 100% financing.

So, these Wall Street investors have decided to fight back. They have collectively determined that second mortgage notes are the absolute riskiest and they are going to limit purchasing them. They have decided to only purchase the best notes. The ones with the least risk. The ones made to people who have some of their own money in the deal and/or only those with better credit.

They have determined that sub-prime notes are also not worth owning unless the borrower has a lot more of his own money in the property, so they are limiting buying those as well unless the borrower has a substantial down payment or a lot of equity on a refinance.

They have determined that notes for borrowers who state their income are far more likely to end up in foreclosure, so they are limiting those to only the better credit score borrowers.

They have determined that first-time homebuyers, without a down payment or a verifiable rental history or a very good credit score, are excessively risky, so they are limiting investing in those Notes as well.

So the mortgage companies that sell the Wall Street investors these Notes, including Countrywide, Option One, New Century, Fremont, Aurora, and nearly every other mortgage lender you or your broker deal with got put on notice from these Wall Street investors.

They were told, “Do business any way you deem necessary but just know that we no longer purchase risky notes, like those listed above.”

Without a place to sell these notes, these banks had to change their guidelines to only allow for notes they can sell and that’s where we are today.

OK, so what does this mean to you and me?

In the last few weeks, nearly all of the mortgage banks have eliminated stated income loan programs for credit scores under 660 that allow for 100% financing.

They want the buyers to have their own money in the deal as they believe that will make them less likely to be willing to lose their home.

If you do an 80/20 loan to cover 100% financing, the 20% second mortgage may be very difficult to obtain. It will be nearly impossible if your credit score is below 660 and you state your income.

If your credit score is less than 620, that makes you sub-prime to most lenders, so you will very likely need a minimum of a 5% down payment and probably more like 10-20%.

If you have to state your income, you should plan on at least a 5%-10% down payment if your credit score is not at least 660.

If you have to state your income, plan on a bank seriously considering your payment shock before approving you. Many new banking guidelines are limiting this to no more than two times your current payment. For example, if you pay $2000 today for your home or rental, it will be difficult, but not impossible, to find you a bank who will allow your new payment to be any higher than $4000.

If you are a first-time homebuyer, and you don’t rent from a professional management company, you should make sure you have cancelled checks to prove your last 12 month rental history and your credit score should be decent. If not, you are likely going to face a greater challenge and possibly a higher interest rate.

If your credit score is not at least 660, and you cannot fully disclose your income, you will find it very hard or very expensive to secure a 100% loan on a new home purchase or refinance.

When I say expensive, I mean if you are doing an 80/20 loan, and your credit score is not at least 660, and you have to state your income, plan on that last 20% costing you between 3-8% on that loan as a loan discount fee, if you can even find it.

If you buy a $300,000 house, and you are doing an 80/20, this means your first mortgage is $240,000 and your second mortgage is $60,000.

Based on these numbers, that second mortgage will cost you a discount fee between $1800 and $4800 just to get that second loan in additional closing costs.

Now this is still certainly less expensive than putting 5% down or $15,000 on this same home, but it does make it much more difficult for the first-time homebuyer and those with little to no money to put down.

Most banks limit seller contributions on 100% programs to 3% of the loan amount so those additional costs on the second mortgage will certainly mean you will need some cash out of pocket.

The sub-prime market, primarily for borrowers under 620 credit scores, is nearly dead today for higher loan to values. If you have between 5%-20% to put down, you should still be OK for now.

Here are some of the other things you can expect to see:

· The lighter your documentation (stated income, stated assets, etc), the higher your down payment and higher your rate.

· The lower your credit score, the higher your down payment, the higher your rate.

· More intense scrutiny from underwriters. They are being told to take their time and be extra careful about every loan they make. Many of them have been fired as a scapegoat for today’s high rate of delinquency. As they land at new companies, you can expect their lesson to be learned.

· The acceptable documentation needed for your loan will likely be more substantial and will need stronger third-party verification like income, employment, previous rental history, reserves, down payment, credit history and depth of credit including more and longer trade-lines.

· All investment loans will likely require 6-12 months in reserves.

· Plan on all loans requiring more reserves and tougher asset seasoning guidelines.

· Option ARM’s will likely only be available with more equity or much more down payment.

· Plan on loans costing your borrowers more on the front end. Banks are dramatically cutting back the Yield Spread Premiums and Rebates paid to brokers and bankers and they will likely pass some of this onto the borrower.

If you have been reading this newsletter for some time, you know that I am an OPTIMIST!!!!

So, what’s the good news here?

The GREAT news is that we still live in one of the most vibrant, incredible real estate markets in the HISTORY OF THE WORLD!!!

People are still moving here in droves and they are going to for many years to come.

In 1989, at the age of 23, I bought my first house. It was in South Shore, on West Lake Mead, at the base of a giant desert that was rumored to soon be a development called Summerlin. I was a first-time homebuyer. I made about $6/hr. working for a television station after graduating from college.

My soon-to-be wife and I found a house we loved for $136,000. That seemed like it was all the money in the world. It was at the time.

I got an 80% loan because that was all I could qualify for and I got a generous gift from my parents to help with the down payment. My interest rate was 12.000% and it was not interest-only.

How I made that payment each month was once featured on a segment of television show called “Unsolved Mysteries.”

The point is we found a way. Las Vegas exploded during those years, as it does today, with people “finding a way.”

There weren’t any interest-only’s or hybrid ARM’s or Option ARM’s or 100% financing for borrowers “one day out of BK.” You had a down payment or you didn’t get a house. You had decent credit or you rented until you could improve. Many lenders did FHA loans and nothing else.

Yet our city exploded. More so than any city in American history.

In my opinion, creative financing did not create the real estate explosion. The real estate explosion created creative financing. Wall Street wanted in and they did so by creating “something for everyone.”

I can remember the days, not that long ago, when I would do tons of FHA loans, that required 3% down payment, and loans that required mortgage insurance, and loans that didn’t go to Wall Street but went straight to “the agencies” like Fannie Mae and Freddie Mac and guess what? Those days are back.

Sure, it will take some time getting used to it and we will have to say “no” a few more times than we did in the past few years. We will talk to a lot more people, try and pre-qualify them, and then we will have to make that call all lenders hate to make. We will deliver the bad news that their dream of homeownership is not today. However, with some good guidance and solid consultation that dream should remain alive as someday it will happen.

And, yes, the timing is horrible when factored against what is already going on in the market with inflated inventory and fewer buyers, so sales and values will likely drop even further from previous years as a result.

However, and this is the important thing to remember, there will still be thousands of home sales each month and more sales here than in most other cities.

I was talking about this subject to one of my reps at one of the biggest mortgage investors in the U.S. He told me his company went through the archives and the lending guidelines are now very similar today to how they were in 2000.

In 2000, a 30-year fixed rate mortgage averaged 7.75%, yet it was the third-best performing year for home sales in the previous 37, according to the U.S. Census Bureau, and Clark County saw its population grow over 300% from 1990. Even with higher interest rates than today and similar lending guidelines, people were buying houses and getting loans.

One more item of optimism for you. 100% financing still exists and likely will exist for borrowers with credit scores over 620 if they can prove their income and 660 for those who state their income.

Please look at the chart below. This is the “National Distribution of FICO Scores” table as found on myfico.com. This breaks down Americans by their credit scores.

800+………….. 13%

750-799………. 27%

700-749………. 18%

650-699………. 15%

600-649………. 12%

550-599………. 8%

500-549………. 5%

under 499…….. 2%

As you can see, nearly six out of 10 have a 700 score or higher and nearly three out of every four Americans have a score 650 or higher. It doesn’t take much work for a seasoned mortgage professional to consult with a 650 on credit clean-up issues to get them over the 660 mark.

And, finally there are still those agency loans like FHA (loan limit now $304,000 in Clark County) and some very exciting Fannie Mae-backed loans that allow for 100% financing for borrowers with less than perfect credit and lower income and the rates are fantastic!

I just got a single mom, school teacher approved this week on 100% financing with a 626 credit score and a debt to income ratio of 55% with an interest rate of 6.000% for a 30 year fixed.

No, it’s not interest-only, and yes, she has to pay mortgage insurance, but last week she was an innocent victim of a Wall Street-backed bank that decided she was too risky. In the next two weeks she will be a proud first-time buyer with a home to raise her kids.

My incredible English professor, Mr. Harrington at Clark High School, once told me to always avoid clichés when writing.

But you know what? Where there’s a will, there’s a way. And, we, real estate professionals, will “will” our way through this, like we always do.

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