Getting A Loan In A Paranoid Lending Environment

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A couple years ago, underwriting standards were way too loose. Lenders were competing for loans, and the presumption was that with real estate having continued to gain in value, it was difficult to actually lose money on real estate. Needless to say, that presumption has now changed. Lenders are stuck on the horns of a dilemma. They have had massive losses on real estate loans, yet real estate loans offer a very large profit center. Furthermore, because The Mortgage Loan Market Controls the Real Estate Market, the more they constrict lending policy, the more they lose on those people who have no choice but to sell. It's a tragedy of the commons type situation, though, as any given lender loosening their loan policy exposes themselves to the risk of a bad loan, while only reaping a fraction of the benefit on their existing loans.

Therefore, the individually rational decision for them is to be very careful that the loans they do make are going to be repaid. And boy are they. Underwriting standards have become completely paranoid. Things that were not an issue at any time in the last ten years are becoming "Loanbusters." There have been quite a few additions to that category of late.

To give an example, I just spent three full days arguing about a rental property my client had 2000 miles away. Because the client had accepted a cash deposit as opposed to a check, they did not want to give my client credit for the monthly rental, despite the fact that the property had been rented for several months. With the rental income, my client was able to satisfy debt to income ratio requirements and the new loan was no risk at all. Without the rental income, debt to income ratio was too high. The client had everything else - bona fide transfer from employer, plenty of income documentation, time in line of work, etcetera, and remember that the property had been rented for several months. But because the basic underwriting standard is to demonstrate payment of a deposit via a canceled check in order to credit rental income, I had to argue the case - along with the reasons for the underwriting standards - up four levels in the process before I got to someone with the authority and understanding of the reasons for the underwriting standards to agree to an alternative standard my client could meet.

You can help yourself in advance of applying for a loan. Have a paper trail for all money - especially anything having to do with any rental property you might own. Document all of your income, especially on your taxes. Pretty much every single loan done right now is requiring IRS form 4506T. The only exceptions I'm aware of are portfolio lenders. Be careful moving your money around, and be certain there is a paper trail sourcing all money that appears on any of your bank statements. Where did the money come from? Also be aware that just because you made $X this month does not mean lenders will necessarily accept your income as being $X per month. In general, income is averaged over the previous two years, so if you've had a big raise you were counting upon for loan qualification, you might not get full credit for it. In case of doubt or dispute, the numbers on your tax form - that you reported to the IRS and paid taxes on - becomes the ultimate fall back.

It has become more expensive to get a loan, and more problematical. Investment properties, in particular, are creating many problems. Since last summer, government loans have required exterior appraisals on investment property (at a cost of about $300 each) and they want to see 30% equity - difficult in the current market. Fortunately, people with investment property have always been comparatively rare on VA and FHA loans due to limits built into those programs. In the last two weeks, however, these standards have spread to conventional Fannie Mae and Freddie Mac loans, a much bigger problem. Once again, portfolio lenders may be the only alternative. Since portfolio lenders tend to have significantly higher rates, not having 30% equity on an investment property can mean you can't get a loan that makes it worthwhile to refinance, and it might mean you can't qualify to buy a property, even if the investment property is thousands of miles away from your current job. Is this brain damaged, or what? However, it's the way things are right now - and I guarantee your loan officer isn't any happier about it than you are.

Rates are great right now - so much so that it's easy for most people to find better loans than the one they've got. Actually qualifying for that loan is much more problematical, and by "qualifying" I mean meeting all of the underwriting and funding standards so that you actually get that loan (the best loan quote in the world isn't going to do any good if the loan can't be funded). My processor is telling me stories of other loan officers she works with that are losing sixty to seventy five percent of the loans they work with. If you don't think that's having an effect on the prices they have to charge and the margin they need on successful loans, you'd better think again. They can only work on so many loans at once!

The importance of this is much greater for purchases than it is for refinances. On a refinance, you still have your existing loan. If the new loan doesn't get funded, it's usually not such a big deal. You still have the property, you still have the existing loan, and you can try again. On a purchase, you've got a good faith deposit at risk on a ticking clock. One loan getting rejected can mean you lose the deposit, the property, and anything you've spent investigating it.

Given this, what advice do I have to give? Underwriting standards and flexibility vary from lender to lender. Because one lender is not willing to compromise on an issue doesn't mean that nobody is. However, for the average person applying with a direct lender, it's a matter of cut and try. If the loan fails, you have to start all over, and that includes paying for a new appraisal. A new inspection, too, if you have to find a new property because the seller got tired of waiting and sold to someone else. All of this is wasteful of money, not to mention your time and patience.

Brokers, however, have already had experience with what lenders are being hardcore and unreasonable about what issues, and which are acting in a matter closer to sane. Furthermore, if you're the one where they find out with a problem at a particular lender, they can resubmit the loan package elsewhere, and because the appraisal is done in their name, they don't need a new appraisal, and brokers can usually use exactly the same loan package except for one piece of paper.

You also want to choose a loan officer who has the time to argue your case with a particular lender, and motivation to do so. If you're one of fifty loans that month, the loan officer doesn't have the three days I spent arguing with underwriters so that you can get the great rate you have locked in - not to mention losing time on a purchase contract if you have to resubmit to a new lender. If your buyer's agent does loans themselves, it might be worth considering for this reason alone. I would like to think I would have argued just as hard anyway, but I wasn't just arguing about a loan that meant a standard commission to me. I was arguing over a loan that meant not only that, but an agency paycheck as well, and the house my new friends had their heart set on, the months of work we spent picking it out and negotiating the sale, and their deposit. I had all the motivation I could possibly want. My processor was floored that I argued it up as far as I did, and that it worked. Most of the loan officers she works with were letting arguments drop a lot earlier than that. Quite a few are basically just wringing their hands in despair. That seems to be consistent with the stories I'm hearing from consumers elsewhere.

Caveat Emptor

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5 Comments

Rob said:

Dan - how hard is it for an independent contractor, like a Real Esate agent, to get a loan or re-fi? I've got a decent credit score, about 700 or so, and want to refi a $600k primary residence (condo) with only a $315k loan. But after all my write offs each year I've got little net income to show, and we're in the winter dry spell for commissions (soon to change) so I don't have much incoming income over the last couple of months. Does the LTV take care of all the other problems? Or is this a difficult to impossible re-fi right now?

Dan Melson Author Profile Page said:

The issue is that you are precisely the person stated income was designed to assist - but once people figured out stated income could be abused (and how easily), it was only a matter of time before it disappeared.

I think your refinance is possible due to the comparatively low LTV through a portfolio lender that offers stated income. There are still a few, but the requirements (particularly reserves) are a lot stiffer than you might be used to. Furthermore, the rates aren't as good as other A paper loans, for reasons I explain in The Return of Portfolio Lending. If you're only looking to refi because you're thinking of rates in the high 4s, that's not a portfolio stated income loan. If, on the other hand, you have a situation like if you hit the adjustment on an ARM, it might very well help you.

looking4loanqual said:

Dan. I am in the exact situation you describe. I have great credit and a solid income. I want to rent my current primary residence and buy another property to live in. Problem is that my curent residence is underwater. Without counting the rental income from the current property, my dti is too high. Where would you suggest I go for a loan? Is it possible?

Dan Melson Author Profile Page said:

This rule is straight from Fannie and Freddie - and whomever has the gold, makes the rules for lending it out.

Your only hope is a portfolio lender, and rates that are significantly higher. No fun, but less no fun than missing out on these great prices for certain. Even with a portfolio lender, you're going to have a very high steep hill to get up to convince them you're not intending buy and bail, as what you describe is a classic buy and bail situation. Unfortunately, the irresponsible few in the current market are ruining things for everyone else. Sinking enough cash into your current residence so that you're not upside-down is the only thing likely to make your loan doable, but better that than the Fannie/Freddie alternative of needing 30% equity!

Chris in California said:

Dan, you sure hit the nail on the head with this article. I am a California attorney with a stable job, verified and documented income, 2 rental properties (one of which is underwater) and a third that I live in currently but that has a 5 year rental history until I owner occupied starting about 6 months ago. I have had 3 rejections so far from lenders who tell me that although my credit (720) is great and no history of defaults/late payments is a good thing, 22% down helps, I'm a "no-go." This is because they won't count my income from either of the underwater properties or any of the additional income I receive weekly in direct commissions from clients per FHA guidelines--and conventional becomes even more problematic.

The irony in all this is that the paranoia in the "buy and bail" presumption against potential borrowers like myself who have absolutely no history of bailing on anything is LUDICROUS. For an attorney it's tantamount to a "guilty until proven innocent" presumption. Even more ironic is the fact that folks like me who have continued to pay for multiple mortgages (in my case, 3) throughout the whole crisis are PRECISELY the borrowers who have ensured that the housing market didn't TOTALLY crash as it might have done.

I am with a lender now who assures me that he's taken it to the VP of his direct lending firm and it has approval...but I still don't have an underwriter's signature and I have adopted the attitude that if it happens, it happens.

I guess I wonder how if the lenders persist in this type of knee-jerk reactionary fashion in denying loans to qualified borrowers like myself, how much lower can the housing market dip? Many experts predict that the option-arms will start adjusting this year and provide a fresh crop of new foreclosures. If that happens in conjunction with this continued policy of irrational paranoia in lending, recovery in the housing sector may be many years in the making...

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This page contains a single entry by Dan Melson published on February 9, 2009 7:00 AM.

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