It had to happen sooner or later. The lower volume of mortgage applications is resulting in some tinkering to find more consumers that can qualify. Fannie Mae, Freddie Mac, and major lenders aren’t necessarily changing the qualification standards but they are moving some pieces of the puzzle around. For instance, around mid-year, Fannie and Freddie raised their debt-to-income ratio limit up to 50 percent from 45 percent of pretax income.
This isn’t likely to lead to a sea change in the number of mortgages being approved. When the change went into effect, Fannie said that borrowers will still need to prove they are low risk, maybe by having a higher credit score. One stated purpose for tinkering with qualifications is for more consumers carrying student debt to be able to qualify. However, in a market where prices are consistently slightly out of reach of many buyers, even those without student debt are likely to qualify at the low end of the market as well as others now being able to qualify for slightly more expensive homes. A recent analysis by the Urban Institute estimated the 45 to 50 percent debt-to-income shift will lead to 95,000 new loans being approved annually nationwide.
FICO (credit score) calculations have also seen some tweaking. The big three credit rating agencies, Equifax, TransUnion, and Experian are dropping tax liens and civil judgments from some consumers' profiles if the information isn't complete. Information missing from these credit dings (such as addresses, dates of birth, and SSN) has resulted in lower credit scores being applied to the wrong person’s credit report.
Fair Isaac Corp. (FICO) says that about 7 percent of the 220 million Americans with a credit profile also have tax lien and/or civil judgement blemishes on their records. It’s not known how many will of these derogatories will be removed but it’s estimated that people that do have them removed will see an average improvement in their credit score of 20 points. This is another good example of why consumers should review their credit profile regularly. A study by the Federal Trade Commission estimates that 20 percent of consumers have at least one error on one of the three credit agency reports.
Student loan debt continues thwarting people with decent incomes from qualifying for mortgages. Student loan debts of $100,000 or more are not uncommon ($200,000 for married couples). A couple might have a combined income exceeding $150,000 per year and still not qualify for a mortgage on a decent home. Not when combined monthly student loan payments are running $2,500 or even $3,000. Lenders are finding ways to improve these people’s ability to qualify for a mortgage. Previously, it was common to calculate monthly payments as 1 percent of the outstanding loans. Now, when a student loan borrower is enrolled in an income-based repayment plan, the lower monthly payment can be used when calculating the debt-to-income ratio. This can result in the monthly payment calculation dropping from thousands each month to $600.
Additionally, once a student loan borrower becomes a homeowner, Fannie will allow them to qualify for a cheaper cash-out refinance if they use it to pay off their high-interest student loans. Another consideration is made when student loans or other non-mortgage debt is paid by parents or others. Those payments will no longer count toward their debt-to-income ratio.
The “new normal” in mortgage qualifications is beginning to take a toll on the mortgage industry as well as the consumer. Higher home prices, reduced inventory, and tight qualification standards have resulted in fewer mortgage applications and fewer approvals. Some lenders are seeing profit margins shrink as much as 20 percent. Times when the only mortgage qualification was being able to fog a mirror are gone. However, when big industry profit margins shrink, it’s time for change.
What are your thoughts about the current state of the mortgage industry? Please comment with your thoughts and experiences.
Author bio: Brian Kline has been investing in real estate for more than 35 years and writing about real estate investing for 10 years. He also draws upon 30 plus years of business experience including 12 years as a manager at Boeing Aircraft Company. Brian currently lives at Lake Cushman, Washington. A vacation destination, a few short miles from a national forest. With the Pacific Ocean a couple of miles in the opposite direction.