Think It’s Hard to Get a Mortgage Loan Now? Just Wait…

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If you’ve been following the housing market in recent months, you’ve probably heard that it’s hard to get a mortgage loan these days. This much is true. Banks are being more strict today than they were before the housing bust. They are requiring higher credit scores, larger down payments, lower debt ratios, and sometimes the cash-reserve equivalent of six months of mortgage payments.

While it’s hard to get a mortgage right now, it may get even harder in the foreseeable future. Recent actions taken by the federal government may force banks to reduce their risks even more. This could put financing out of reach for many would-be home buyers, thereby slowing recovery in the housing sector.

Federal Government Sues Banks for Billions

On Friday, the Federal Housing Finance Agency (FHFA), a federal agency that oversees Freddie Mac and Fannie Mae, filed suit against 17 mortgage lenders in the United States. The charge? Selling mortgage “lemons” to Freddie Mac and Fannie Mae.

The federal government is suing the banks for breaking federal securities laws relating to the sale of mortgage-backed securities. Among other things, the FHFA claims that the banks misrepresented the quality of the securities in order to sell them, downplaying the high-risk nature of the loans.

The government has sued a total of 17 financial companies, including some of the biggest names in the mortgage world. Some of the banks names in the suit include Bank of America, Ally Financial, HSBC, JPMorgan Chase and Goldman Sachs. Absent from the list was Wells Fargo, the largest mortgage lender in the United States.

The FHFA claims that some of the losses incurred by Freddie Mac and Fannie Mae were due to “misrepresentations and other improper actions by the firms and individuals named in these filings.”

This is not the first time the government has taken legal action against the banks. It has happened several times since the housing crash began in 2008. In January of 2011, Bank of America settled a legal dispute with Freddie Mac and Fannie Mae over bad loans made by Countrywide Financial (which BofA purchased). On that occasion, Bank of America paid almost $3 billion to settle the case.

The difference this time around is that more banks are being named in the suit, and the combined settlement could be enormous. The question is, how will this legal action affect the already-struggling housing market? It’s too soon to tell. But if history is any indication, it’s going to get even harder for home buyers to qualify for a mortgage loan.

Hard to Get a Mortgage in 2011; Even Harder in 2012?

When Bank of America had to dole out billions of dollars to settle a dispute, it tightened up its mortgage-lending criteria. Coincidence. I don’t think so. When banks suffer large losses, the first thing they do is minimize risk. Sure, they still need to strive for profits to keep their shareholders happy. But risk reduction is priority #1 in such scenarios. That’s why BofA has been turning down so many borrowers who seem to be well qualified.

I spoke to a loan officer at a smaller bank recently who said that most of his business these days is from “BofA turn-downs” (i.e., borrowers who have been rejected by Bank of America.) “These are people who had solid qualifications,” she said. “Sometimes we look at their files and scratch our heads as to why they were turned down in the first place.”

One of our writers was one of these BofA casualties.

It’s hard to get a mortgage loan today, when compared to the days of easy credit during the housing boom. My guess is that it’s going to get even harder. If the banks end up paying billions to settle their individual disputes, it could send a ripple effect through the housing market. Their definition of a “well qualified borrower” will likely be more strict than it is right now. They may require larger down payments, higher credit scores, and additional cash reserves above and beyond the other home-buying expenses. We’ve seen this happen once already. We have every reason to expect it to happen again.

It’s notable that Wells Fargo was not named in this suit. Borrowers who have trouble qualifying for a mortgage with other lenders might want to give Wells Fargo a try. If most of their legal troubles are behind them, the country’s largest lender could take even more market share from the other banks — by welcoming the borrowers they turn down.

Borrowers should also consider their state and local banks when shopping for a mortgage loan. They often have more relaxed underwriting guidelines, when compared to the big banks. It might not be as hard to get a mortgage from a smaller company that’s not being sued by the federal government.