Anyone watching or reading the financial news over the last few months and years has seen a lot of angst and consternation over the state of the Mortgage industry. In fact, many of the larger lenders in the US, American Home Mortgage, for example, was forced to shut down operations. But WHY? Let’s look beyond the HEADLINES, so that you really understand THE TRUTH behind the headlines.

In 2000 and 2001, Real Estate was HOT – make that WHITE HOT. According to the S&P/Case-Shiller Home Price Composite 10 Index, an Index that follows Home prices, values increased 21.5% from the years 1990-1999. During the first two years of this decade alone, Home prices increased 23.6% for the same Index. This resulted in a period of wildly loose lending guidelines that would ultimately fuel the Subprime Mortgage collapse in 2008.

In retrospect, it’s easy to see, and even understand, the mistakes that were made during this unusual period of growth. Rapidly escalating Home prices not only eased economic and personal financial woes, they invited opportunity and risk whose rewards, while hard to resist, couldn’t possibly be sustained at such a high level. Nonetheless, increasing Equity created flexibility that benefitted Buyers and Sellers alike – as long as property values continued to ascend.

During this time, many loans were made to Homeowners with somewhat Non-Traditional or “Non-Conforming” situations, be it a poor credit history, inability to document income, or any number of factors that do not fit within the traditional “box” for Home Loans. These loans are often called “Sub-Prime”, or “Alt-A”, meaning that they were somewhat riskier in nature than A credit, prime, or traditional loans. Another type of “Non-Conforming” Home Loan is one where the Credit and Income might be perfectly fine, but the loan amount is higher than $417K, which is the current maximum loan that can be done using pools of money from mortgage giants Fannie Mae (FNMA) and Freddie Mac (FHLMC). If the loan amount is higher, it can certainly be done – it’s called a “Jumbo Loan” – but the end money comes from private institutions, not from the large Government sponsored entities of Fannie and Freddie.

But, as the Real Estate Market began to turn and the Economy began to suffer, Home values slowed and then ground to a halt, and the true risk in the Market was exposed. No longer supported by skyrocketing Home values, Borrowers had fewer options, Lending Guidelines tightened, Adjustable Rate Mortgages adjusted, resulting in a crash in the Market that is only now just beginning to turn.

What Does This Mean to Borrowers Today?

Simply put, Home lending has returned to what insiders call a “Full-Doc world.” This means lenders need proof, documented evidence that a Borrower is creditworthy and likely to repay the loan. This creditworthiness is based on the four tenets of lending: the Borrower’s ability to pay, willingness to pay, equity in the transaction, and the property itself.

Ability to Pay

This is the documentation portion of the equation. In determining one’s ability to repay a loan, it is now common for a lender to ask for recent paystubs, W-2s, and possibly Tax Returns in the case of a salaried employee. For Self-Employed Borrowers and those earning commissions, Tax Returns for the two most recent years and a profit and loss statement for the current calendar year will likely be required. While certain exceptions may be granted, potential Borrowers can further increase their chances of securing a Mortgage by keeping their Debt-To-Income (DTI) level below 45%.

Willingness to Pay

Repercussions of the credit crisis have made FICO scores more important than ever to lenders. In order to obtain the best Interest Rate and have a broader selection of loan programs from which to choose, potential Borrowers should strive to keep their FICO score above 720.

Borrowers whose scores fall below 720 where the loan will be sold to Fannie Mae and Freddie Mac can expect risk-based pricing, which could result in either higher Costs or higher Rates. So, while it is possible to get a loan with scores as low as 620, programs other than Fannie Mae or Freddie Mac are probably the best path for a Borrower with a lower score to take.

Equity in the Transaction

With the exception of Mortgage programs guaranteed by the USDA and VA, No-Down-Payment Loans have pretty much evaporated on a national level. Today it is expected that Borrowers put a minimum of 3.5% down for an FHA loan and 5%-10% down for agency loans sold to Fannie Mae or Freddie Mac.

If someone is strapped for cash, however, it is still possible in the purchase contract to negotiate with the Seller to pay a percentage of the Closing Costs, as long as it’s within the program’s limitations and the property appraises highly enough for this action to be permitted.

With the exception of the President’s Home Stability Plan, it is no longer possible to Refinance a loan without Equity in the property. However, under this plan, millions of Homeowners are expected to be able to take advantage of being able to Refinance at a loan-to-value of up to 105% of the Appraised Value.

Cash-out Refinancing has also been tightened, compared to just a few years ago. While pulling equity out of a Home is still possible, the costs to do so have become more expensive for Homes with a higher loan-to-value. Depending on the program, Cash-Out transactions have generally been limited to a maximum of 85% of the Home’s appraised value.

The Property

Home appraisals are also being more scrutinized today to ensure the value of the Home is both fair and realistic for lender and Borrower alike. On May 1st, new legislation (Home Value Code of Conduct or HVCC) placed a barrier between loan originators and appraisers for loans sold to Fannie Mae and Freddie Mac (legislation does not affect Mortgages guaranteed by the FHA, USDA or VA.)

For those loans impacted by HVCC, all parties involved should be prepared for potential delays. If value conflicts occur, Sellers, Buyers, Homeowners, and Real Estate Agents must be prepared to provide information where needed.

In locations of the country where property values have been in significant decline, additional documentation may be required by the appraiser to help the lender justify the appraised value.

In Summary

Yes, getting a Mortgage may be more difficult than it was a few years ago, but don’t assume that you can’t get one. I am here to help and advise during these volatile times – and would welcome calls from you, your friends, family, neighbors or coworkers.

Reports suggest that over $2.7 Trillion in loans will be originated in 2009 – that’s over $1 Trillion more than 2008. With Interest Rates at or near all time lows, lower Home prices, and more than $8,000 in Tax Credits for First-Time Buyers, it’s worth the time and effort to find out if you can benefit from common-sense lending in today’s Real Estate Market.

Whether or not you are currently in the market for a New Purchase, Investment or Refinance we hope that this information is of value to you.  Let us show you how to manage the risk of “Outliving Your Assets.”  If you’re thinking of moving up or Refinancing, or know someone who is, please pass along my contact info to anyone you know in need of the advice of a knowledgeable Real Estate Asset Manager professional.

The next time you’re in a conversation with a friend, family member, or neighbor and they mention that they are interested in owning a New Home or improving their existing Cash Flow or minimizing Interest Expense, would you please tell them you have a friend in the Wealth Creation business that can give them advice they can trust?  Then email me and let me know the best way to get in contact with them.