Foreclosure and Real Estate Blogs

Here’s a quick primer on residential lending, and why someone should or shouldn’t qualify for a loan.

There are three main facets to a good underwriting decision.  One is credit history, the second is employment/income, the third is down payment/assets.

Credit History
Credit is scored on an alphabetical grade scale with A credit being very good with maybe a late payment or two over the past few years, with those late payments being explained by a written letter.  B + C credit will have multiple credit dings, maybe some collections, but no real huge credit issues.  D credit is going to have major lates, including possible mortgage lates.  A credit gets the prime, advertised interest rates, B+C have to pay a premium in interest rates, D is what is consider sub-prime.  Credit factors can be compensated for/overcome in residential lending if income is high, or there is a large downpayment or equity in a home.
Many lenders will use a FICO credit score to determine creditworthiness, in a FICO score ,720 or more is good, 620 or below is getting in the sub-prime category.

Employment/Income
The last two years of employment is the most important in a lending decision.  Two years with the same company, or in similar industries, with a steadily rising income can predict a probability that the borrower will continue with steady employment, allowing them to make their housing payment on time.  The general rule of thumb is that a borrower shouldn’t be paying more than 33% of their gross (before taxes) income on housing, including their principal and interest on the loan, property taxes, and hazard insurance on the home.

Down Payment/Assets
The traditional standard is a borrower should be putting 20% down payment on a home.  Homeownership rates have increased by relaxing those standards, mortgage insurance(MI) protecting the lender for losses they may suffer above that 80% Loan To Value point started the ball rolling, lender programs offering both a first and second loan totalling sometimes more than the value of the property continued the low down payment phenomenon.  Typically, a borrower should have at least two or three months worth of housing payments in cash at a bank or somewhere it can be quickly obtained if there is an emergency requiring those funds to keep a home loan current.

A solid borrower should have good credit, stable employment/work history and a little bit of financial cushion in case of life issues.
A slightly more risky borrower will have issues with one of those three, but have other strong characteristics.
A risky borrower is one that doesn’t really have any strength in any of those facets.

“Countrywide Financial Corp., the biggest U.S. mortgage lender, fell 13 percent, the most since the 1987 stock-market crash, after Merrill Lynch & Co. raised the possibility of bankruptcy. “Effective insolvency” would result if creditors force Countrywide to sell assets at depressed prices or investors lose confidence in its ability to raise cash, Kenneth Bruce, a Merrill analyst in San Francisco, said in a research note today.”

Countrywide Falls; Merrill Cites Bankruptcy Prospect (Update4)

It’s a little scary when one of the largest U.S. residential lenders loses half their value in less than a year. What makes it worse for Countrywide is their cost of business is now increasing due to the higher rates they pay for funding. Will this continue spreading until there aren’t any more residential loans? No. But, I do believe this credit market is going to get a lot tighter, leading to a tipping point in real estate markets that haven’t yet headed south. No loans, or highly expensive loans lead to fewer real estate sales which leads to price reductions as the only way possible to move property.
Interesting times indeed.

“Reid-Williams tried for months to refinance the house she bought in Yeadon eight years ago, but recently decided against it - to avoid a $4,000 penalty for paying off her existing loan early, she said.This is quite a contrast from two years ago. When Reid-Williams refinanced in 2005, it seemed like the lender was coming to her rescue with money she needed to pay off her car and other bills. When it was too late, she read the fine print.”

From philly.com 

The problem isn’t just limited to Philadelphia, or any one income/credit group.  The past few years have seen huge gains in real estate prices in many parts of the U.S., much of it driven by the ease of obtaining credit.  Subprime loans aren’t the only “funny” credit product that created the current situation.  Alt-A, which was designed for self-employed borrowers who either could not or did not want to verify income also was used extensively over the past few years.

What I see as a key point is the 48,000 risky mortgages given in the eight county Philadelphia area in 2005.  Each of those mortgages probably represents a home where the owner is going to probably have payment issues in the next 1-3 years.  How much can an eight county area absorb?  Assuming their real estate is “normal” with buyers and sellers doing their “normal” thing, what happens when you put another 3,000 homes for sale in that market?  What if it’s 6,000 homes?

Is this the making of the perfect storm?  Credit is tightening due to the lenders and funds going belly up from the current default rates on the bad loans, home values in many areas are flat or dropping, and there’s a huge number of loans with their payments increasing.
Can’t refi due to no equity.
Can’t refi due to new credit standards.
Can’t make the new payments because the new payment is $500 more.

Yeah, there is some significant pain coming over the next few years.

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