Lending Standards Hurt Housing Economy

Story first appeared in USA TODAY.
Home buyers such as Bob and Janet Zych have fueled the U.S. housing market for decades. They have excellent credit with scores that top 800, life-long careers and investment portfolios that have set them up for a comfortable retirement, they say.
But this year, after faxing a ream of paper about their finances, they got so fed up applying for a home loan that they simply wrote a check for their new, $85,000 vacation condo in Phoenix.
Trying to get a loan was just a nightmare, says Bob Zych, 65, a manager for Mohawk Industries in Omaha.
Following the greatest housing crash since the Great Depression, home lending standards have tightened to their strictest levels in decades, economists say. And people such as the Zychs and others nationwide are paying the price.
Tight home loan credit is affecting everything from home sales to household finances. Many borrowers are struggling to qualify for loans to buy homes. Others can't take advantage of some of the lowest interest rates in 50 years because they don't have enough equity in their homes to refinance. Those who can get loans need higher credit scores and bigger down payments than they would have in recent years. They face more demands to prove their incomes, verify assets, show steady employment and explain things such as new credit cards and small bank account deposits.
Even then, they may not qualify for the lowest interest rates.
The National Association of Realtors says lending standards are too tight and are hurting the housing industry's recovery.
The lending industry counters that standards are where they need to be, given still-falling home prices and the shaky economy.
Down payment amounts rise
The change is evident in the higher quality of loans held by government entities, which now buy or guarantee most new home loans.
Lenders that originate loans seek to meet their standards so that they don't have to hold loans themselves.
Through June, single-family home loans bought by government-backed Freddie Mac, for example, had an average down payment of 29% and an average FICO credit score of 751, the agency says. That's up from average down payments of 23% for loans originated in 2007 and average FICO scores of 707, Freddie Mac says.
FICO scores top out at 850. The national median is 711, FICO says.
New Federal Housing Administration loans, popular with home buyers who lack big down payments, likewise are being made to borrowers with higher credit scores.
From January through March, those loans went to borrowers with an average credit score of 704, up from 631 four years ago, FHA data show.
Even the worthiest borrowers have to put down more money than a few years ago to get the best loan terms.
Real estate website Zillow analyzed 3.6 million loan inquiries made through its website to mortgage lenders since 2008.
In July, prospective borrowers getting the best loan rates had average down payments of 28%. Three years ago, before the worst of the financial crisis, such shoppers averaged down payments of less than 24%, according to data from Zillow Mortgage Marketplace.
A struggle to close
Sometimes, even borrowers with seemingly pristine finances are struggling to close home loans.
Stephanie, 45, and Brian Poore, 46, of Hubert, N.C., went through two lenders this year before the third extended them a loan on an $86,000 condominium in Wilmington, N.C. The couple bought the condo for their daughters, ages 19, 16 and 15, to use during college.
The first lender went overboard on income questions, Brian Poore says, asking him to prove that he didn't pay for room or board while living on an Army base in Iraq, where he works as a contractor.
Another lender qualified the couple for a loan, given their credit scores above 780 and other financial resources. But then the lender backed off, saying it couldn't resell the loan to Fannie Mae because the condominium homeowners association didn't have enough cash reserves for maintenance and repairs.
With the third lender, the Poores had to put 25% down — not the 15% they originally intended.
The process took five months. The loan was for $67,000. One of the Poores' relatives recently bought a new car and got a $55,000 loan in less than a day, Stephanie Poore says.
The Zychs were hamstrung by lenders' concerns about their previous investments.
During the past five years, they acquired three rental properties — all in Omaha — that were leased and produce a positive cash flow for the couple. When the Zychs went to buy the Phoenix condo, lenders balked, saying they had too many properties, even though their finances were solid.
Roberta Fernandes, 24, a first-time home buyer, got a loan. But not without help. She needed almost 50% down to get a loan to buy her Miami condo in June. Fernandes is an assistant to a financial adviser at a brokerage firm. Her short work history hindered her ability to get loans with smaller down payments.
Her parents put up more than half the required down payment. Without their help, getting a loan would have been impossible, Fernandes says.
Jose, 40, and Ivelte Hidalgo, 35, also recently bought in Miami. Jose started a medical research consulting business in 2007. Ivelte works in the business, too.
Because they were newly self-employed, the couple were turned down by two lenders for home loans in 2008 and 2009.
They finally secured an FHA loan for a $280,000 house, which they purchased this summer. The couple put 3.5% down, the FHA's minimum.
With higher down payment requirements and tighter standards for conventional loans, the FHA has become a major player in the home-lending market.
For the first six months of this year, almost 51% of loans to buy homes were done through the FHA. That's up from 3.4% in 2007, says Inside Mortgage Finance.
But FHA loans aren't always the best deal.
Although they have smaller down payment requirements than conventional loans and credit criteria that are not as strict, there are limits on how big FHA loans can get.
FHA borrowers also pay a 1% upfront fee that conventional borrowers don't pay. And if buyers have enough money for larger down payments, they can avoid higher FHA premiums for mortgage insurance, which protects against default.
It can also take longer to get rid of mortgage insurance on an FHA loan than on a conventional loan, says Keith Gumbinger of mortgage tracker HSH.com.
Conventional loans with less than 20% down are available. However, such borrowers need mortgage insurance. In general, the lower the down payment, the more one pays in mortgage insurance. Interest rates also rise as credit scores drop.
For some properties — including those needing bigger loans, condominiums and homes in areas hard hit by the real estate crash — 20% or more down payments are the norm, says Greg McBride of Bankrate.com.
Nearly all borrowers are facing more documentation requests.
Except for a few years leading up to the real estate crash — when some borrowers got loans while providing little if any documentation of their assets and income — borrowers have long had to supply two years of tax returns, pay stubs and financial statements when applying for home loans.
Now, lenders want tax records to come directly from the IRS, as well as from borrowers. The IRS releases the records after applicants sign forms giving it permission to do so. Instead of two months of bank statements and pay stubs, lenders may want them for each pay period until the loan closes.
Howard Landa, a California physician, purchased a $900,000 home in Moraga, Calif., last year and refinanced it this year. The refinance lender wanted pay stubs for every two weeks as the loan was in process, which took almost two months.
Landa also had to explain a new Macy's credit card line, which he opened to qualify for a discount on a suit he bought from the retailer.
When he bought the house, Landa had almost enough money to pay cash for it. He also had an outstanding credit score of 810. Even so, the lender carefully checked his income, even requiring copies — front and back — of several $500 and $1,000 checks he deposited in his checking account after being reimbursed for travel expenses.
Reduced risks = fewer defaults
Higher standards do appear to be reducing loan defaults, which means fewer foreclosures in the future.
Fewer than 1.3% of loans originated in 2009 that were resold to Freddie Mac and Fannie Mae went into default after 18 months, government data show. That's down from more than 22% default rates for 2007 loans and about 3% default rates in 2002.
Avoiding defaults has become a primary goal of wary lenders, says Walters, the Quicken Loans economist.
They fear loans will go bad and the investors that buy them — such as Freddie Mac, Fannie Mae or others — will discover mistakes and sue the originating lender.
Many such lawsuits are underway.
Walters says their line of defense is to cross T's 42 times and dot I's 52 times. With home prices continuing to fall across much of the nation, lenders realize that any mistake could be fatal, he says.
Yet, the National Association of Realtors, and a number of consumer groups, say the tight standards are also a drag on the economy.
The NAR estimates that home sales — stuck at anemic levels — would jump 15% to 20% if lending standards simply returned to where they were a decade ago, before they got so loose they helped create the real estate bubble that later popped.
However, lending standards are unlikely to loosen until home prices stabilize, says mortgage loan expert Jason Kopcak of investment bank Cantor Fitzgerald. Nationwide, home prices are down 30% from their 2006 peak and are expected to fall more this year.

ILLEGAL ROBO-SIGNING CONTINUES

Lawmakers and enforcement agencies called for hearings and further investigation Tuesday after learning that the illegal practice known as robo-signing has continued in the mortgage industry.
The Associated Press reported on Monday that county officials in at least three states - Massachusetts, North Carolina and Michigan - say they have received thousands of mortgage documents with questionable signatures since last fall. That's when forged signatures and false affidavits - also called robo-signing - led to a temporary halt to foreclosures. Banks and mortgage processers promised to stop the practice. But the findings of the county officials indicate that robo-signing is still a widespread problem.
Sen. Sherrod Brown, D-Ohio., chair of the Financial Institutions and Consumer Protection Subcommittee, said the subcommittee will hold a hearing on the robo-signing issue.
Wall Street and some in Washington want the public to believe that robo-signing is a thing of the past, but the same risky practices that put our economy on the brink of collapse continue to infect the housing market.
Rep. Maxine Waters, D-Calif., a senior member of the House Committee on Financial Services said the lenders who continue the practice need to be investigated and prosecuted. She believed regulators should step in and that the absence of stronger regulation is the reason why the system broke down in the first place" She said the county officials' findings show lenders will not stop
County officials, who are responsible for keeping land records, including property deeds, say that they have received thousands of robo-signed documents filed in their offices since October.
In Essex County, Mass., the office that handles property deeds has received almost 1,300 documents since October with the signature of "Linda Green," but in 22 different handwriting styles and with many different titles.
In Guilford County, N.C., the office that records deeds says it received 456 documents with suspect signatures from Oct. 1, 2010, through June 30. And in Michigan, a fraud investigator who works on behalf of homeowners says he has uncovered documents filed this year bearing the purported signature of Marshall Isaacs, an attorney with foreclosure law firm.
Early Tuesday, an official from the office of Minnesota attorney general, Lori Swanson, contacted the Essex County's John O'Brien to get more information for its own investigation into robo-signing. The Massachusetts attorney general's office also confirmed that it is meeting with several of the state's 21 registers of deeds to assess the extent of robo-signing in the state.
Also on Tuesday, nine recorders of deeds in Illinois held a press conference to say they will assist the state's attorney general Lisa Madigan who is investigating robo-signing in her state.
Rep. Waters, meanwhile, says the Office of the Comptroller of the Currency, or the OCC, is the main federal regulator for banks. As such, it's the OCC's responsibility to investigate the banks.
The OCC has been criticized by lawmakers and consumer advocates for going easy on banks in the past. The same criticism has resurfaced since the robo-signing scandal broke in September. Last fall, The Associated Press found that robo-signed documents led to banks wrongfully foreclosing on people who had paid their mortgages in full. When asked about the issue, an OCC spokesman flatly denied that any such thing had ever occurred.
The OCC partnered with other federal regulators and conducted a review of bank procedures including robo-signing in December. In April, the 14 largest national banks entered into a consent decree with the OCC in which they vowed to submit action plans as to how they would address such systemic issues as robo-signing.
Last week, the banks delivered those action plans to the OCC, which is now reviewing them, a spokesman said.

Private Lenders Provide Option for Borrowers

As lending standards have become tougher, a rising number of people and businesses are turning to an unlikely source for money: private lenders.

In recent years, the practice of borrowing money from private parties was rare, except among those who were unable to qualify for traditional loans. Banks were flush with cash and eager to lend, meaning even people with a tarnished credit history often could find quick sources of cash.

Now, even those with good credit are bypassing banks to borrow money -- despite interest rates that can reach 20% or more, and down payments of 35% or more.

These private funds -- which aren't from banks or credit unions -- are being used for everything from second homes to apartment construction. Many borrowers have excellent credit, but they are trying to avoid the added time, scrutiny and uncertainty of a conventional bank loan. Such transactions are "not as publicly available as one might expect," says Ron Phipps, a real-estate broker in Warwick, R.I., "but there is definitely money available."

Arrangements for such loans are equally low-key. While hedge funds and high-net-worth investors are providing cash, it isn't unusual for a private lawyer to get five friends to each throw in $100,000 for a home loan. Wealthy investors, hedge funds and private-equity firms are lending money in pursuit of consistently higher returns. The bear market for stocks may make alternative investments such as this type of lending more attractive.

Typically, borrowers hear about private loans from lawyers, mortgage brokers and real-estate agents. Borrowing and lending opportunities are even sometimes posted on Web sites or in newspapers.

For investors, well-structured deals could reap significant returns, because private lenders typically charge much higher closing costs and interest rates than traditional lenders. They also require a much higher loan-to-equity ratio. So if the borrower falls behind, the lender potentially could resell the property at a profit.

"For the investors, there's an opportunity," says Scott Haislet, owner of LEC Mortgage in Lafayette, Calif. "But you better know who is in charge and who's making the decisions about the property."

Borrowers "need to make sure they understand the way the loan works," says Allen Fishbein, director of housing for the Consumer Federation of America. Mr. Fishbein recommends that borrowers "seek out independent professional advice before committing themselves."

The tight credit market makes the loans especially appealing to borrowers, who a few years ago might not have considered the option. "In times like these, when money is tight, private money flourishes," Mr. Haislet says. Stricter lending standards make it more difficult for borrowers with good credit scores to get large loans or so-called bridge loans, which someone might use during a construction project. If you are considering a home-equity loan for a construction project, also consider a home warranty. A home warranty service contract will cover the repair or replacement of many common home repairs and replacements.

Even borrowers with excellent credit scores can wait weeks for a loan to be approved. Occasionally, those deals evaporate, leaving builders and home buyers scrambling for cash. That is where private lenders step in. It isn't unusual for these lenders to charge several points and interest rates of 12% or significantly higher. They also typically require borrowers to provide 35% or more of the down payment, so there is ample collateral if anything goes wrong.

Mr. Haislet, who arranges some private loans, warns that "they're not for everyone. If borrowers can find a better alternative, they should take it, but sometimes there are no other alternatives."

Mr. Haislet says most of the private loans are for less than five years -- and sometimes only six months, for those doing home-renovation projects who could otherwise not borrow the money.

He says his borrowers typically pay 9% to 11%, compared with many current bank rates of less than 7%. The loan-to-value ratios also are much larger.

By: Jilian Mincer
Wall Street Journal; July 31, 2008

Fed Extends Lending Programs as Threats Persist

Move Reflects Worry Over 'Fragile' State Of Financial Market

A year after credit markets seized up, the Federal Reserve is still struggling with the crisis and expanding key lending programs that were designed as temporary measures to nurse the financial system back to health.

The central bank announced Wednesday that it is extending programs through January that allow investment banks to borrow from the Fed. The move is an effort to prevent a worsening in what the Fed described as "continued fragile circumstances in financial markets."

Troubles in the financial world continue to take the Fed deeper into new territory in its effort to prevent a larger credit crunch. The financial sector's weakness is a key reason why policy makers are likely to hold interest rates steady at 2% when they meet next week. A handful of officials are pushing for rate boosts in the near future to get ahead of inflation risks, but most policy makers appear to support staying on hold at least until financial markets can return to a more normal state of functioning. Continued weakness in housing and labor markets also is weighing on many officials.

For the past year, Fed officials have sought to separate their policy actions directed toward financial stability -- emergency lending to financial firms, for instance -- with their monetary-policy role of guiding the economy by setting interest rates. That distinction would allow the Fed to continue its aggressive lending role without being constrained on interest-rate policy if, for instance, it needed to respond to inflation risks.

For now, however, top Fed officials remain especially worried that today's market conditions could deepen the credit crunch by preventing banks from making loans to consumers and businesses. Banks' losses on mortgage loans in particular are wearing down their balance sheets, forcing them to raise large amounts of capital that would allow them to extend credit to consumers. A rate boost now could further aggravate markets while firms are trying to recapitalize. Even though credit markets have improved from their worst points over the past year, they remain far more strained than they were before the credit crisis started last August.

"Healthy economic growth depends on well-functioning financial markets," Fed Chairman Ben Bernanke told lawmakers this month. "Consequently, helping the financial markets to return to more normal functioning will continue to be a top priority of the Federal Reserve."

The Fed's extension of its loan program for securities firms, started in March after the collapse of Bear Stearns Cos., allows the investment banks to take overnight loans directly from the Fed's discount window. That program, known as the primary-dealer credit facility, was set to expire in September.

The Fed extended the program through Jan. 30, though it said "the facilities would be withdrawn should the board determine that conditions in financial markets are no longer unusual and exigent." The move extends the length of the Fed's support to investment banks into the next presidential administration and Congress, which is likely to restart the debate then over whether such firms should get direct lending support.

The Fed's timeline indicates officials believe markets could remain weak, needing a backstop into the beginning of the year. How and when to conclude the program remains in doubt.

"When does it end? It ends a little bit when the liquidity needs start to abate," said Ray Stone of Stone & McCarthy Research Associates. "It's certainly not going to happen soon."

The central bank altered or expanded several programs to address apparent needs of financial institutions and prevent further stress on financial markets.

The Fed extended through January a $200 billion program that allows investment banks to receive 28-day loans of Treasury securities through an auction. In addition, the Fed launched a new program to auction options of up to $50 billion under that program -- the term securities lending facility -- "for exercise in advance of periods that are typically characterized by elevated stress in financial markets, such as quarter ends." That may prevent further market stresses at turning points when firms are closely managing their books, and allows firms to effectively buy insurance instead of carrying the securities over the term. The Fed offered a related program at the turn of the millennium to maintain stability through the Y2K transition.

The Fed carried out a long-sought extension of its auctioned loans for commercial banks. Those will now be available for 84 days in addition to the 28-day loans under the term auction facility. That program was created as an alternative to the Fed's discount window, which is generally used by banks for last-minute funding needs but can carry a stigma because an institution fears being seen as troubled. The $25 billion auctions for 84-day loans will start Aug. 11 and alternate biweekly with $75 billion in 28-day loans. The total credit available under that program will be $150 billion.

The central bank also said it would increase the size of a swap line with the European Central Bank to $55 billion from $50 billion to accommodate a temporary increase in the amount of U.S. dollars the ECB can auction. The ECB and Swiss National Bank are extending 84-day loans in addition to 28-day funds. The Swiss central bank's swap line remains at $12 billion.

Demand for the dollar funding has been rising at each auction since May. In the most recent auction Tuesday, 63 banks bid more than $101 billion for the $25 billion auction. That was the highest number of institutions to bid, and the highest ratio of demand to the amount of funds available, since the ECB opened its swap line with the Fed in December.

Most Fed officials support the efforts to improve market functioning. But their views on the financial situation vary. On one end, officials view the latest market stresses as a source of concern but one that shouldn't stand in the way of raising rates to reverse the aggressive easing -- from 5.25% last September. Officials on the other end believe conditions have worsened dramatically in the past month -- as seen through higher mortgage costs, shrunken bank balance sheets and wider credit spreads -- and add risks to the economy.

While the second quarter delivered strong growth, activity may slow once the effect of economic-stimulus payments fades. High energy prices, a weakening labor market and continued troubles in the housing sector could join tightening credit conditions as restraints to growth into the end of the year.

At the same time, officials are bracing for high inflation readings. Oil this month has pulled off its record high by roughly $20, and gasoline has dropped back under $4 a gallon. Both developments could support a moderating inflation rate in the coming months. But prices remain volatile, and officials are putting little faith in the pullback.