It’s harder to get a mortgage loan these days. You’ve probably heard that statement more times than you can count. But now we have some numbers to help illustrate the point.
According to an analysis done by the Wall Street Journal, the nation’s ten largest lenders denied 26.8 percent of mortgage loan applications in 2010. That’s an increase over the year before, when 23.5 percent of applications were rejected.
Texas, Mississippi and Vermont had the highest percentage of denial. Each of those states had a 40-percent rejection rate.
This data fuels the argument many are making that lenders have over-corrected in recent years. Lending standards during the housing boom were ridiculously lax. No one can deny that. Those were the days of no-documentation loans and subprime mortgages for people with terrible credit. Clearly, some higher standards were needed.
But some economists argue that banks have swung too far in the other direction, by becoming too strict. This comes at a time when demand is already softened by unemployment and falling home prices.
Lewis Ranieri, the so-called “godfather” of mortgage financing, is one of those who think lenders have gone too far. “The pendulum has swung too far in the other direction,” he said recently. Ranieri pointed out that many borrowers with good credit and stable income are being denied by mortgage lenders.
As you might have guessed, the National Association of Realtors is also in this camp. NAR spokesperson Walter Molony said the banks are being “stingy” by rejecting creditworthy borrowers.
Real-world example: A staff writer for the Home Buying Institute had his mortgage application rejected by Bank of America. He had a credit score over 800, which is considered excellent by most lenders. He had stable income and plenty of money for closing costs. It was the cash-reserve requirement that tripped him up. His story is a good example of creditworthy borrowers being turned down by lenders.
Can a Happy Medium Exist in the Housing Market?
Overly strict lending standards will delay recovery in the housing market. This much is unfortunate. But we shouldn’t be so hasty in urging the banks to ease up. Let’s not forget that lax guidelines helped fuel the housing crisis in the first place.
Trying to cure the housing market with the same practices that wrecked it is a fool’s strategy. The best approach would be for lenders to refine their automated underwriting guidelines to account for the bigger picture.
Let’s say a borrower has excellent credit, stable income, and a ten-percent down payment. But he falls short of the lender’s cash-reserve requirement. The lender wants borrowers to have three months worth of mortgage payments in reserve. But this person only has two months of reserves.
This is an example of a well-qualified borrower failing to meet an overly rigid requirement. The lender should base their decision on the big picture. This is a low-risk situation for the bank. Who cares if the borrower doesn’t meet their cash-reserve requirements? It’s a paper requirement anyway. Borrowers could blow their “reserves” on a vacation or a new car two days after closing. So what’s the point?
This kind of scenario happens every day. Borrowers with good credit and income are being turned down because they’ve tripped a red flag in the system. The underwriting system says they meet the basic guidelines set forth by Fannie Mae and Freddie Mac. But they fall short of some “overlay” requirement imposed by the lender. Thus, they are denied the loan.
Banks should be able to establish their own requirements for risk reduction. That’s just good business. But when qualified borrowers are being turned away in droves, there’s something wrong with the system.
In the early 2000s, it was a borrowers’ paradise. Anyone could qualify for a mortgage loan back then. And look where that led us. Now we are at the other end of the spectrum, with overly strict requirements. This kind of rigidity will keep qualified borrowers out of the market and delay any significant recovery in the housing market.
Housing recovery will begin when we find a happy medium.