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Mortgage Professionals Of America

Credit, debt dings don’t always doom mortgage applications

KENNETH R. HARNEY on Feb 3, 2017

WASHINGTON – How tough is it to get approved for a mortgage? How low can your FICO credit score go before your lender shows you the door? And how much monthly debt can you be shouldering – credit cards, student loans, auto payments – but still walk away with the mortgage you’re seeking?

You might be surprised. New data from technology company Ellie Mae, whose loan application and management software is widely used in the mortgage field, reveals that even if you’ve got what seems to be a deal-killing low FICO score or you’re carrying a mountain of debt, you still might have a shot at qualifying for a mortgage to buy the house you want.

Consider some of these findings from Ellie Mae’s latest sampling of recently closed loan applications nationwide-

- FICO scores on most successful applicants remain well above historical averages, but significant numbers of home buyers are squeaking through with sub-par scores. (FICO scores run from 300 to 850, with the upper end of the scale indicating lower risk of default.) Though the vast majority of lenders shy away from – or absolutely rule out – applications with FICO scores below 620 or 640, applicants with scores that are sometimes 100 points below are being approved and funded.

Roughly 5 percent of all Federal Housing Administration (FHA) insured loans closed in December had FICO scores below 600; 3.4 percent had FICOs between 550 and 599, and 1.5 percent scored between 500 and 549. FHA, whose role in the marketplace is to provide a doorway to homeownership for applicants who could have difficulties being approved for “conventional” loans – those eligible for sale to giant investors Fannie Mae and Freddie Mac – still pulls in plenty of applicants with solid scores. Thirty seven percent of approved applicants had FICO scores of 700 to 799 in December. But the majority – 56 percent – had FICOs between 600 and 699.

Meanwhile, even in the more exclusive conventional marketplace, there are big variations in acceptable scores. Thirteen percent of home buyers whose conventional loans closed in Decembers had FICOs ranging from 650 to 699.

- Debt-to-income (DTI) ratios have more wiggle room in them than you might assume. Though the typical buyers whose conventional loans were closed in December had “back end” debt ratios averaging 35 percent, at FHA the average was 42 percent. (The back-end DTI ratio measures buyers’ total monthly debt obligations, including payments due on their new mortgage, against their monthly gross income.) Depending on other factors in the application, conventional lenders generally have flexibility to push the ratio to 45 percent, while FHA lenders can go considerably higher in some cases, even above 50 percent. That’s scary high for most people, but loans like these are getting done routinely.

- Down payments can be much smaller than a lot of buyers sitting on the sidelines might think. The average down payment on VA (Veterans) mortgages in December was just 2 percent – and that’s higher than the VA’s bare minimum requirement, which is zero down. FHA’s minimum is 3.5 percent and the typical approved applicant came close to that at 4 percent down. The average conventional down payment on home purchase mortgages was 20 percent but both Fannie Mae and Freddie Mac offer loans that require just 3 percent down. A few lenders – most prominently Quicken Loans – have cut that to as little as 1 percent down.

So how do buyers with sub-par FICOs, skimpy down payments and high DTIs manage to get a mortgage? The key is this- They don’t have these negative factors rolled into their applications all at once. If they did, they’d be rejected. If they’ve got a weak FICO, they need strong “compensating factors” elsewhere in their application to counter-balance the credit score deficiency. Maybe it’s a larger down payment than typical, a lower than average DTI or higher bank reserves. Maybe you’ve got a co-borrower with solid financials to ease the lender’s concerns. Maybe you are able to afford a slightly higher rate on the loan. Whatever the compensating factors are, you absolutely need them.

John Walsh, president of Total Mortgage Services, a Connecticut-based lender active in 44 states, told me “it’s all about the total picture,” not just one glaring negative. “The whole application has to make sense.” So if you look terrible in one area of your application, don’t give up. If you can bring other strengths to the table, you’ve got a chance – even in a tough lending environment.

Republicans may change tax code to make property swaps less attractive

Defenders of tax-deferred exchanges say small investors may lose incentives to upgrade their holdings.

By Kenneth R. Harney January 25

The small-scale owners of millions of rental homes, parcels of investment land and income-producing commercial and business real estate may not know it, but one of their key financial planning and tax tools is in danger of disappearing on Capitol Hill.

House Republicans are working on a proposal that, as part of an overall streamlining of the Internal Revenue Code and a reduction in tax rates, may eliminate or seriously restrict the use of tax-deferred exchanges – property swaps – under Section 1031 of the code. President Trump has identified tax revision as one of his top priorities, and legislation is expected to move quickly in the new Congress.

In a tax-deferred exchange, owners can postpone recognition of gains on investment real estate when they swap one property for another of “like kind.” The capital gains tax that would otherwise be due gets deferred until the owner sells the replacement property and receives cash.

Under Section 1031, which has been part of the tax code since 1921, a rental house in Santa Barbara, Calif., might be exchanged for an investment duplex in suburban Chicago. Oklahoma farmland could be exchanged for rental condos in Washington, Boston or Miami. Exchanges are also used to further environmental protection objectives, such as through swaps involving conservation easements to preserve habitat and prevent future development.

To qualify for tax deferral, exchanges must follow a detailed set of IRS rules specifying the timing for identifying replacement properties and transaction closing deadlines. An entire industry of what are called “qualified intermediaries” exists to facilitate exchanges by escrowing proceeds and administering transactions to comply with IRS rules. Fixer-upper houses and other real estate held for short periods and then flipped to new purchasers do not qualify for tax-deferred exchanges, nor do owner-occupied residences.

Loss of the ability to use an exchange would be a significant blow to “Mom and Pop” and other small-scale realty investors. According to a study posted on the website of the National Rental Home Council, there were 15.7 million rental homes in the United States as of 2015, and 99 percent of them were owned by noninstitutional investors. A study by professors at the University of Florida and Syracuse University estimated that most exchanges involve relatively small properties; in 2011, 59 percent had a sale price of less than $1 million.

Bill Horan of Realty Exchange Corp. in Gainesville, Va., told me about recent transactions that illustrate some of the objectives of tax-deferred property swaps. In one, a rental property owner exchanged it for two Dollar General stores. The owner “didn’t want to be a daily landlord anymore,” which involved hands-on management duties and liabilities, Horan said. By rolling his rental housing gains and equity into “triple net” leased retail properties, where the tenants essentially are responsible for everything, he was able to simplify his life, diversify his portfolio and potentially make greater gains in the future with retail real estate.

Another small investor swapped a rental home in Virginia for a rental condo in Fort Myers, Fla., where he intends to move for retirement. “He wanted to own property near where he’s going to live,” Horan said. Because the Fort Myers unit cost $412,000 and the rental home he relinquished was valued at $525,000, the investor ended up paying a modest amount of capital gains taxes.

Exchanges have been on congressional tax writers’ hit lists before, in part because they generate tax “expenditures” – losses of otherwise immediately collectible revenue for the federal government. In December 2015, the congressional Joint Committee on Taxation estimated that during fiscal 2017, exchanges would generate tax expenditures of $11.7 billion attributable to corporations and $6 billion attributable to individual taxpayers. For the same year, by comparison, revenue losses caused by deductions for mortgage interest and local property taxes by individual homeowners were much larger: $84.3 billion and $36.9 billion, respectively.

Exchange proponents, such as Suzanne Baker of Investment Property Exchange Services in Chicago, argue that most of the deferred taxes ultimately are collected when properties get sold for cash and that exchanges stimulate economic activity – redevelopment and upgrades of properties, for example – that would not occur if owners faced immediate taxes on their gains and therefore simply sat on them.

Bottom line: If you own investment real estate and have contemplated a Section 1031 exchange, be aware: There’s a significant possibility that tax revisions could knock your plans off track. Keep a close eye on what’s happening, because it could happen fast.

Update: As noted as a possibility in last week’s Nation’s Housing column, the Trump administration has suspended indefinitely the reduction in FHA home mortgage insurance premiums that had been scheduled to take effect Jan. 27.

Premium reduction is good news – but might be fleeting

KENNETH R. HARNEY on Jan 20, 2017

Published in The Nation’s Housing

WASHINGTON – Here’s some potentially good news for anyone seeking a low down payment mortgage without high credit scores- The Federal Housing Administration is cutting its mortgage insurance premium charges, making its loans a little more affordable.

But if this sounds attractive, be aware that it could be temporary. Although the Obama administration scheduled the reduction to take effect on new FHA loans insured on or after Jan. 27, there could be a problem. Key House Republicans have objected to the cost reduction and are pressing the incoming Trump administration to reverse it. At his confirmation hearing, Ben Carson, nominee to be the new secretary of the Department of Housing and Urban Development, said if confirmed, he would “examine” whether it’s a good move or not.

The premium reduction is not huge – just one quarter of one percent off the previous charge – but it will lower FHA monthly mortgage payments at a time when the rest of the market is trending costlier because of rising interest rates. Consider this scenario prepared for this column by Michael Zimmerman, senior vice president of MGIC, a major private mortgage insurer based in Milwaukee.

Say you want to buy a house and find one for $220,000, which is slightly below the median national price of existing homes at the end of last year. You’ve got a 720 FICO credit score and can make a 5 percent down payment, resulting in a loan amount of $209,000. Before the cut in FHA fees, at typical interest rates quoted earlier this month, you’d have paid $1,153 monthly (exclusive of property taxes and hazard insurance) for an FHA-insured mortgage. The same loan but with private mortgage insurance would have cost $2 more a month – $1,155. On monthly payments, your FHA loan and a conventional Fannie/Freddie alternative would have cost about the same.

After the premium reduction, however, the monthly cost for the FHA loan will be $45 cheaper than the competing conventional loan – a cost advantage of $540

the first year. For larger sized loans, the savings will be greater. No big deal? It depends- For new home buyers short of cash, any savings can be important. Plus at the application stage, the lower mortgage cost helps buyers’ debt-to income (DTI) ratio calculations – a crucial factor in loan approvals and rejections.

What about first-timers who can’t come up with any more than the absolute minimal down payment allowed on either FHA (3.5 percent) or Fannie/Freddie conventional mortgages (3 percent)? Here the cost differentials become significantly greater. Purchasing the same $220,000 house with a 720 FICO score and a 3.5 percent down payment FHA loan will cost you $129 less per month following the premium reduction compared with a 3 percent down conventional loan eligible for sale to Fannie Mae or Freddie Mac, according to an analysis prepared by Paul Skeens, president of Colonial Mortgage Group, a lender based in Waldorf, Maryland. The FHA payment comes to $1,088.45, the conventional loan payment to $1,217.45.

You might say, wow, it looks like for new low down payment buyers, FHA is always the way to go. But that’s not the case. Keep these pros and cons in mind when you comparison shop for a mortgage requiring minimal dollars down-

- Both FHA and conventional loans require payment of mortgage insurance premiums. But FHA loans come with a glaring negative- Unlike private mortgage insurance, FHA premiums are non-cancellable for the life of the loan if you make less than a 10 percent down payment. With a conventional loan, you get to cancel your premium payments when you achieve a 20 percent equity stake in the house. That can occur when your principal payments reduce your debt to 80 percent of the original balance or an increase in the market value of your house grows your equity. When your loan balance declines to 78 percent – your equity is 22 percent – your loan servicer is required by federal law to terminate premium payments.

- On the plus side, FHA has far more generous and forgiving underwriting rules on credit, debt-to-income ratios and financial assistance from home sellers to help with buyers’ closing costs. It exists to serve working families and individuals who might otherwise find it difficult to get an affordable loan. If your FICO credit score is below 720 and you can cobble together a 3.5 percent down payment, FHA is usually the right choice. The new, lower premiums merely underline that fact.

When will Fannie and Freddie switch to a new credit-scoring model?

KENNETH R. HARNEY on Dec 2, 2016

WASHINGTON – You probably know that your credit score is a crucial factor in your ability to qualify for a mortgage. You might also know that your score can vary depending on the type of scoring model your lender uses. If it’s an old, outdated version you might get a lower score. If it’s a newer, more advanced model, you’ve got a better shot at being scored more fairly.

Which brings up an end-of-the-year controversy- The two behemoths of the mortgage business – Fannie Mae and Freddie Mac – continue to use a credit scoring model that even its developer, FICO, says is not as “predictive” as its much newer models. Worse yet, Fannie and Freddie require that all lenders who want to submit loan applications to them must also use the same, outdated technology.

The net result, say critics from the lending industry, consumer groups, civil rights organizations and a bipartisan coalition of legislators in Congress, is that many applicants don’t get the credit scores they deserve. Many other consumers – the estimates range above 30 million – aren’t even scoreable using the models currently employed at Fannie and Freddie. Disproportionately, critics say, these are people who don’t make heavy use of the credit system or who are young and don’t have much information on file with the national credit bureaus. Large numbers of them might qualify for a mortgage, say scoring experts, if they were simply given a fair shot.

Acknowledging the problem, Fannie’s and Freddie’s government regulator, the Federal Housing Finance Agency, directed the companies two years ago to begin examining how to improve their scoring systems. For 2016, the FHFA told them to “conclude [their] assessment,” and “as appropriate, plan for implementation” of a better approach.

Since it’s now December and there have been no announcements about possible reforms, I thought it appropriate to ask this question- When are Fannie and Freddie rolling out their new and improved scoring models and what will they look like? The question is especially timely given the release in late November of a new study from the Urban Institute documenting how recent credit standards in the mortgage arena have impacted millions of would-be borrowers.

Researchers found that roughly 1.1 million home loan applicants were turned down last year because the standards used to evaluate them have been much more stringent than they were in the pre-housing boom era, when defaults were relatively low. Between 2009 and 2015, “lenders would have issued 6.3 million additional mortgages,” researchers calculated, “if lending standards had been more reasonable,” as they were back in 2001.

A major culprit- a big shift toward the credit score elite when it comes to mortgage approvals. From 2001 through 2015, the share of borrowers approved for mortgages with FICO scores above 700 rose to 66 percent from 51 percent, while those approved with scores below 660 declined to just 14 percent from 31 percent. Credit scores of approved applicants at Fannie and Freddie this year alone have averaged between 752 and 754, according to loan technology firm Ellie Mae. Meanwhile, the average score among all Americans is just 699, according to score developer FICO. (FICO scores range from 300 to 850, with low scores indicating higher risks of default.)

In response to my question, a spokesperson for the FHFA told me that Fannie and Freddie continue to discuss their plans for scoring reforms with “a broad range of stakeholders” about the “cost, operational implications, and potential impacts on access to credit.”

Who are some of these “stakeholders” and how do they see this issue? Among the most directly affected are the banks and mortgage companies who deal with the two companies daily. They strongly favor a move to more advanced scoring models as a way to broaden the base of potential home buyers and borrowers without exposing themselves or Fannie and Freddie to higher risks of default.

Michael Fratantoni, chief economist for the Mortgage Bankers Association, told me in an interview that “by sticking to old models we are disadvantaging” sizable numbers of consumers. Groups such as Fratantoni’s also want to see the introduction of advanced scoring models from companies other than FICO – VantageScore Solutions, LLC offers a rival system now in use in most other segments of lending – as an option permitted by Fannie and Freddie.

“We are on the record for more competition in this space,” Fratantoni said. “We shouldn’t be locked into just one set of scores.”

Nor should potentially millions of credit-worthy consumers.

Freddie Mac planning appraisal-free mortgages

Kenneth R. Harney on Nov 11, 2016

WASHINGTON – Can computers, big data and advanced analytics replace real live humans when it comes to accurately valuing the home you want to buy? One of the two largest financial players in U.S. real estate thinks so and is preparing to introduce changes that could prove momentous – and highly controversial.

Giant mortgage investor Freddie Mac plans to dispense with traditional appraisals on some loan applications for home purchases, replacing them with an alternative valuation system that would be free of charge to both lenders and borrowers. The company confirmed to me last week that it could begin the no-appraisal concept as early as next spring. Instead of using professional appraisers, Freddie plans to tap into what it says is a vast trove of data it has assembled on millions of existing houses nationwide, supplement that with additional, unspecified information related to valuation, and use the results in its assessments of applications.

For consumers, the company believes, this could not only eliminate appraisal expenses – which typically range from $350 to $600 or more – but could cut down on current closing delays attributable to appraisals. It could also relieve lenders of their current burdens of responsibility for the accuracy of appraisals – a major sore point with banks that sell loans to Freddie subject to potential “buy back” demands if significant errors are later found in appraisals.

But critics argue that Freddie is headed down a perilous road. Doing away with formal appraisals by trained professionals could massively increase the company’s exposure to future losses on defaults, they say, and would likely end up being paid for by American taxpayers. Reliance on publicly available data without careful physical inspections of properties verges on “craziness,” said Joe Adamaitis, residential lending manager for Insignia Bank in Sarasota, Florida. “We would never allow it here.”

Not surprisingly, appraisers who know about the plans are up in arms. The Chicago-based Appraisal Institute, the largest professional group in the valuation field, has written to Freddie Mac’s regulator, Mel Watt, director of the Federal Housing Finance Agency, urging him to take a hard look. Freddie Mac’s “decision to veer away from fundamental risk management practices appears to harken back to the loan production-driven days in the years leading up to the 2007-2008 financial crisis” – abuses that “turned out to be disastrous for the entire economy,” the group wrote.

Veteran appraisers such as Pat Turner of Richmond, Virginia, believe that abandoning traditional valuation practices will leave Freddie Mac essentially “flying blind” in many instances. In a phone interview, he said he has inspected houses where the interior damage and neglect have been so extensive – none of it on public records or visible to automated systems – that the differences in market value arrived at by a computer compared with a trained professional are potentially catastrophic for any investor. Similarly, without an inspection, an automated valuation might not reflect whatever significant improvements you’ve made that are not on any public records.

For years an outspoken critic of the popular but frequently inaccurate automated valuation systems offered free by Zillow and other websites, Turner asked- “When was the last time a Zillow computer walked into your house?” Computerized estimates “can’t tell you everything you need to know about value,” said Turner.

But Freddie’s idea has strong defenders in the mortgage industry. Jay Farner, president of Quicken Loans, headquartered in Detroit and the second largest retail mortgage lender, told me “we’re in support of doing something to alleviate the situation today,” where appraisal delays can cause rate locks to expire and closings to be postponed.

Though “a large percentage of loans do require an appraisal,” he said, others could be safely underwritten with a combination of strong previous valuation data on the property, possibly combined with a “walk-through” inspection.

Bill Dallas, chairman and CEO of Skyline Financial Corp in Calabasas, California, calls the traditional use of appraisers “a really screwed up system.” He’d like to see the industry move toward an approach that makes maximum use of the huge property-specific databases built up from previous appraisals along with inspections when needed.

Where’s this all headed? We’ll begin to know in a few months. But don’t expect appraisers to suddenly disappear. The best of them add essential value to the process of telling a lender or investor what a house is truly worth, based on up-to-the-minute market information and a hands-on physical inspection – services no computer can perform, at least not yet.

Category: American mortgage

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