I recently had a conversation with the vice president of the last mortgage company I worked for, one that I had been affiliated with from 2000 until 2008. A colorful speaker, he described the current mortgage approval process as ?every loan is like going through a barbed wire enema?. The process, he said, has become confusing and arbitrary. But stand by, it looks like we?re in store for even tighter mortgage restrictions.
The Consumer Financial Protection Bureau – which has been instrumental in implementing tighter mortgage restrictions in the aftermath of the housing/mortgage meltdown ? is getting ready to issue a new round of tighter guidelines that will make getting a mortgage even more difficult. The changes are set to take effect in 2014.
Mortgage rules are getting even tighter
According to US News & World Report, several new changes are coming down the pike and they?re restrictive.
A lower fixed debt ratio. A new combined debt ratio of 43% of stable gross monthly income will become the new standard. The debt ratio includes not only your house payment, but also any other recurring monthly debts that you have, including credit cards, car loans, and child support payments. To put that into perspective, during the boom conditions that prevailed until 2007, mortgages were routinely approved with debt ratios as high as 60% and even 70%.
Including more debts in the ratio. The lower debt ratio will be compounded by the fact that will also include certain debts that were excluded in the past. This includes student loans, which were typically were excluded from the debt ratio if you had a deferral of at least 12 months. With more people having larger student loan debts than just a few years ago, this can be a bigger problem than it seems on the surface.
Stricter income verification. The no income verification loans of the boom years are now long gone. The lenders will be required to implement stricter verification requirements of any income considered. Stability will become a more important factor than it has been in the past.
Lower ?jumbo? mortgage threshold. In response to the mortgage meltdown, the threshold for jumbo mortgage loans ? mortgages and access the maximum limits allowed by Fannie Mae and Freddie Mac ? are set to drop from $625,000 to somewhere in the neighborhood $400,000. This is designed to put more emphasis on non-agency lenders coming back into the market. We?ll see if that happens.
The mortgage meltdown was partially caused by tighter mortgage restrictions
While it is generally believed that the mortgage meltdown was caused by an implosion in sub-prime mortgages, the reality is that there are multiple intervening factors.
In an attempt to contain mortgage defaults, mortgage agencies and individual lenders began tightening lending restrictions as the market declined. If we were heading into a crisis based on homeowners being overextended, it was made worse by the tighter restrictions.
Tighter mortgage restrictions reduce the number of people who qualify for mortgages, and that lowers real estate liquidity. After all, as millions are shut out of the mortgage market, there are fewer potential buyers, which eventually leads to lower housing prices. As housing prices drop, the ability to sell or refinance a property is constrained, and the situation gets far worse.
The housing market remains soft
Despite all the giddy reports of the rebounding housing market, the market remains soft, at least if we use 2006 as a standard.
According to the National Association of Realtors (NAR), the median price on an existing home sale in July 2013 was $213,500, compared to $230,400 in July 2006. Not only have we not yet attained the price levels of the peak of the market, but there remains negative appreciation for the past seven years.
The number of existing housing units sold is also painting a picture of a soft market. While existing sales are running at 5.39 million in July 2013, sales for 2006 were around 6.5 million. The situation is even worse with new-home sales. Sales are running at 421,000 for August, 2013; for all of 2006 the number exceeded 2 million.
In support of this decline of new housing sales, I can say that in the Atlanta Metro area where I live, there?s nothing now like the brushfire suburban development that was taking place during the housing boom. This is noteworthy because Atlanta has traditionally been one of the biggest new home construction markets in the country.
One more factor that may be worth mentioning: all-cash sales now comprise 31 percent of housing transactions, compared to 20% at the peak of the market in 2006. We can presume that this reflects the growing wealth of the top 1% or 2% of the population over the past few years, but that may be inflating housing sales stats, apart from the mortgage dependent middle-class.
An unholy marriage: tighter lending restrictions and higher interest rates
Tighter mortgage restrictions, in and of themselves, are not necessarily a bad thing. In fact, it was the lack of restrictions that fueled the boom of the 1990s and early 2000?s, and ultimately caused the housing crash. But at this stage in the game, when we are still slowly recovering from that blow up, tighter mortgage restrictions put a damper on the recovery.
But that?s not the worst of it.
Since the early 1980s, housing and the mortgage industry have benefited from a steady 30 year decline in interest rates. Until May 2013 we had the lowest mortgage rates in history. That is an exceptional situation that is guaranteed to change.
The combination of tighter mortgage restrictions and higher interest rates could unleash Real Estate and Mortgage Meltdown Part II. The dominoes are lining up.
Developing a personal housing strategy
What does that mean to you if you?re a homeowner, or looking to become one in the near future?
Create a plan to payoff your mortgage. If interest rates rise and tighter mortgage restrictions are implemented, you may not be able to refinance your house. Next best strategy: payoff your mortgage and end your mortgage dependency forever. It won?t happen over night, so now is the time to get started.
Find the best deal possible. The combination of tighter mortgage restrictions and higher interest rates is very likely to cause house prices to drop. With that in mind, it is important to get a good deal on a house, and even to buy one at less than the current market level. This will give you some equity protection in the event of another general decline in property values.
Save and make the largest down payment you can. Most conventional mortgages today require at least 20% down. Plan on putting down 30%, 40%, or even 50% or more. The size of your down payment is, and always has been, a major factor in the mortgage approval decision. The large down payment will also give you greater equity, which will also protect you in a price decline.
Focus on income stability. At the height of the boom years, people would get out of bed and decide to buy a house that day. At least that?s the way it often seemed to me when I was in the business. There was no advance preparation for making the mortgage application ? no saving up for a down payment (?I?ll go zero down or get a gift from Uncle Joe?), no cleaning up credit, and little concern about income (no income verification to the rescue). That is no longer the case, and apparently will be even less so in the future. Start getting your financial house in order at least a year before you decide to apply for a mortgage.
Pay down or pay off debt. The lower debt ratio is a signal that the mortgage industry is becoming less tolerant of non-housing debt. Pay down, or payoff, as much of it is you can before you apply for the mortgage.
Consider renting. If tighter mortgage restrictions, higher interest rates, and the prospect of further declines in property values spooks you, you might consider renting a house instead of owning one. Not everyone needs to be a homeowner, and certainly not at all times. Even a partial return to the dark days of the mortgage meltdown may be sufficient incentive to stay out of the market. Bonus: you may get a better deal on a house after the next plunge in property values.
That seems to be where we?re heading.
Glowing media, political and industry reports aside, what do you think of the current housing market, and it?s future prospects? Has it all been ?fixed? as so many claim?