The year is drawing to a close, and that means it’s time for our annual mortgage update. This report is meant to educate home buyers on the state of the mortgage market in 2012. We will discuss mortgage rate forecasts for 2012, financing options, qualification criteria and more.
Rate Predictions for 2012
Mortgage rates are expected to remain below 5% for much of 2012, if not for the entire year. This is basically a continuation of what we have seen in 2011. Average rates for a 30-year fixed mortgage remained below 5% for most of 2011, as well. They hovered in the 4% range for the last four months of the year. (Source: Freddie Mac’s weekly survey of the primary mortgage market).
Many experts anticipate that this trend will continue in 2012. Jay Brinkmann, chief economist at the Mortgage Bankers Association, is one of these experts. In November 2011 he make a prediction that 30-year fixed mortgage rates would stay below 5% throughout 2012.
[Related: Housing market predictions for 2012]
Historically speaking, these are very low rates. So they should serve as an enticement for anyone seeking a mortgage in 2012. Granted, many would-be home buyers won’t be able to enjoy these low rates, because they won’t qualify for a home loan. It’s harder to qualify for a mortgage today than it was before the housing crisis began. This is another trend that will likely continue in 2012. And that brings us to our next topic.
Only Highly Qualified Borrowers Will Get Approved
Borrowers with shaky credit, unstable employment or excessive debt will have trouble qualifying for a mortgage loan in 2012. This should come as no surprise. We’ve been hearing about tougher lending requirements in the news for the last three years.
In some cases, borrowers who seem well-qualified are being turned down due to overly strict requirements, such as cash reserves. You can read our story about a borrower with excellent credit who got rejected by Bank of America for this very reason. We have received hundreds of similar stories from readers over the past year.
In order to qualify for a mortgage in 2012, borrowers will need to have their financial ducks in a row. They will likely need credit scores in the low 600s or higher. They will need stable employment and income, with sufficient documentation to prove both. Debt levels must not exceed a certain amount, in relation to the borrower’s income. We will talk more about these requirements below.
Fewer Mortgage Options in 2012
This is another continuation of a trend from the last three years. Most real estate professionals will be familiar with this subject. But first-time home buyers will be less familiar with it, so it needs to be addressed.
Home buyers will have fewer mortgage options to choose from in 2012. This is a direct result of the housing crisis that came to a head in 2008 — a crisis we are still wrestling with, by the way. During the housing boom, a variety of mortgage options were used to qualify borrowers with questionable credentials. Most of these so-called “exotic” mortgage products have disappeared. Here’s what home buyers can expect in 2012:
Stated income loans are no longer available in many areas. This was a mortgage product that allowed borrowers to be approved based on their stated income, without any documentation to back it up. Though widely used in the years leading up to the housing crash, these loans have been less available since. We expect this trend to continue in 2012 as well.
The same goes for the closely related limited-documentation loans. Also referred to as “no doc” mortgage loans, this financing option required little in the way of documentary evidence. Here again, the borrower could simply state his or her assets and earnings, and receive approval based on those statements. Borrowers who apply for a mortgage loan in 2012 will have to document everything. The lender will want to see documents supporting the borrower’s employment, income, assets, debt obligations and more.
Piggyback loans will be less available in 2012, but are still common in some areas. This is when the borrower uses two mortgage loans to finance the bulk of the purchase price, in order to avoid private mortgage insurance (PMI). These changes seem to be regional in nature. In some states, borrowers may still have the piggyback mortgage option in 2012. In other states, such as California, they have all but disappeared. We have queried a number of mortgage brokers and lenders in the Golden State, and most of them said they no longer offered piggyback loans. Borrowers should research this topic at the state and local level.
FHA Home Loans Are Still Wildly Popular
We expect the FHA loan program to remain a popular option among home buyers in 2012. Borrowers flock to this program for two reasons in particular. The down-payment requirement is generally smaller than a conventional loan, and the qualification process is easier in some regards.
From 2006 to 2010, the FHA’s market share rose from around 5% of total purchase-loan activity, to 40% of mortgage activity. This is directly related to the two factors mentioned above. Their market share declined slightly in 2011, but the FHA program will remain a popular financing option in 2012.
We conducted a survey in May of 2010 that revealed the primary motivation for using an FHA home loan. According to the survey, the biggest appeal of this program is the low down-payment requirement. Borrowers with a qualifying credit score can make a down payment as low as 3.5% of the purchase price (when using the FHA program). This is lower than the typical down payment required on a conventional loan. And that brings us to our next 2012 mortgage topic:
Down Payment Requirements in 2012
We already discussed the 3.5% down payment option for FHA home loans. In order to qualify for this option, borrowers must have a credit score of 580 or higher. Otherwise, they might be required to make a down payment of 10% on an FHA loan. There are lender overlays to consider as well. In 2012, we expect that many lenders will require a credit score of 600 or higher on FHA loans.
Certain borrowers will have the option of 100% financing. For example, the VA loan program is still alive and well. This program allows qualifying military members to buy a house with no down payment whatsoever. The USDA loan program offers similar financing terms for low-income families in designated rural areas.
We anticipate most lenders will require a down payment of at least 5% for conventional mortgage loans in 2012. In 2011, some lenders were requiring minimum down payments of 10%, and this trend could continue in 2012.
Borrowers who put down less than 20% will probably have to pay for private mortgage insurance. This extra cost can be avoided if the borrower combines two mortgage loans, where neither loan accounts for more than 80% of the purchase price. This is the piggyback loan option we discussed earlier. The 80-10-10 mortgage is a good example of this strategy. This is where the borrower gets a first mortgage for 80% of the purchase price, a second loan for 10%, and pays the remaining 10% in the form of a down payment. In 2012, the piggyback financing option may only be available to borrowers in certain states.
Borrowers Should Consider Using Smaller Lenders
Over the last couple of years, we have heard numerous stories of borrowers who were rejected by the big banks and then later approved by smaller banks. Here is an example of such a story. In many cases, the big banks (Bank of America, Wells Fargo, Citi, etc.) have rigid requirements that smaller lenders are willing to relax.
Cash reserves are a good example. One of our writers was rejected by Bank of America because he did not have six months worth of cash reserves. He was using the VA loan program to buy a house. He then applied for a loan through a smaller lender that did not have cash-reserve overlays on VA loans. His Bank of America ordeal lasted several months and ended with rejection. Using the smaller bank, he was approved in two weeks and faced no cash-reserve requirements.
Borrowers should also consider local banks and credit unions. We conducted a survey in 2011 that showed most consumers prefer working with smaller banks. In many cases, these institutions are more flexible with their qualification criteria. They may offer lower rates to their existing customers, as well.
The point is that borrowers should explore all of their mortgage options in 2012. Granted, it helps to meet the minimum criteria for mortgage approval. This means having a good credit score, a manageable level of debt, and stable employment. A poorly qualified borrower may find nothing but closed doors, no matter how many times he knocks.
Credit Score Needed To Get a Mortgage Loan
We queried a number of mortgage lenders across the country to get a feel for their credit-score requirements. Please note that these guidelines are not set in stone. They simply represent the trends we have been seeing in 2011 — trends we expect to see more of in 2012. In order to qualify for a mortgage loan in 2012, borrowers may be held to the following standards:
- Many lenders are requiring a credit score of 640 or higher for conventional loans.
- Lenders are generally more flexible with FHA loans. Some said they will allow credit scores of 600 or higher under the FHA mortgage program.
- In February 2011, there was news of Wells Fargo lowering its credit-score requirement on FHA loans. According to the New York Times, they had lowered their minimum score to 500 (which coincides with the federal government’s minimum requirement). We could not confirm if this standard will continue in 2012.
All of the numbers above relate to basic mortgage approval. This is what might be required just to get your foot in the door. In order to qualify for the lender’s best rates, a borrower will probably need a credit score of 740 or higher.
Borrowers with bad credit should not despair. There are proactive steps you can take to improve your credit score, and often significantly. We have written about this subject in great detail elsewhere on the website. Here is an article that explains some of the steps you can take to boost your score. With the right approach, a borrower who has bad credit at the start of the year could still qualify for a mortgage later in 2012. It takes some discipline, but it can be done.
Basic Qualification Criteria
We’ve discussed the qualification criteria for mortgage loans throughout this guide. Here is a summary of what lenders are looking for when approving loans in 2012. These rules are not set in stone, but they do reflect our conversations with lenders throughout 2011.
Definition of a well-qualified borrower:
- The borrower has a credit score of 640 or higher. *
- The borrower has a manageable level of debt. Her combined that (taking into account the mortgage payments) should not use up more than 50% of our monthly income. A debt to income ratio below 40% is even better.
- The borrower has had stable employment for at least 2 years. This can be documented by a letter from the employer.
- The borrower has a down payment of at least 5% for a conventional loan, or 3.5% for an FHA loan.
* Borrowers with scores below 640 may still qualify for an FHA loan. They might qualify for a conventional loan as well, though they will pay a much higher rate.
This article provides an overview of what borrowers should know about mortgage loans in 2012. But there is certainly more to learn on the subject. Future home buyers may wish to download our 2012 buyer’s guide, which is available for free. It offers more than 180 pages of information pertaining to mortgage loans, credit scores, and other aspects of the home buying process.
Home buyers should also continue their research beyond this website. There are many resources available online to help you learn about mortgages and home buying. Consumers can also get one-on-one counseling for little or no cost, by using a HUD-approved housing counselor. This is a great way to learn about your mortgage options in 2012.