If you pay attention to print and broadcast media, you’ve seen stories—lots of them—about how hard getting a mortgage is today. Just browse through a week’s worth of Seattle Times or any other paper and you’ll see them. Banks have been upping their standards, they say, cherry picking only the very best applicants with flawless credit scores, lots of money in the bank for large down payments, and long tenure at the same job.
Are banks being super picky?
One noted economist says that banks are being so picky because today’s low interest rates, combined with suffocating regulations, mean that they don’t make enough money on each loan to justify accepting anyone other than near-perfect borrowers. Some researchers point to very high average credit scores (754 last year) as evidence that the banks have raised their standards high enough to exclude many or most applicants.
There are some problems with this narrative. First, it discourages those would-be homeowners who may have a few blemishes on their credit reports, and who may not have been able to save up 20% cash or more for a down payment. Those people, a sizable group, decide not to apply for fear of being rejected.
Second, it is completely false.
What’s the REAL story?
The truth is this: the vast majority of people with a credit score of 620 or higher and an ability to document their income and assets will be able to get a conventional mortgage for as much as 97% of the property’s purchase price. If a borrower’s low score is the result of current collection accounts or judgments, they’ll have to deal with them in some way; but their loan will be approved. Borrowers with scores as low as 580 can get an FHA loan with as little as 3.5% down.
Most loan applications today are processed using an Automated Underwriting System, or AUS. Mortgage giants Fannie Mae and Freddie Mac provide the two most commonly used. If an applicant’s loan is approved through the AUS and the loan officer has correctly input the borrower’s income and assets, most lenders will approve the loan.
Do lenders drag their feet?
Some journalists in Washington and other states have claimed in widely circulated articles that lenders are reluctant to make loans to less-than-perfect borrowers because with today’s low rates, they don’t make enough money. Those who make these claims clearly do not understand how lenders originate and fund mortgages.
How mortgage lending really works
The lender, a mortgage bank, takes a loan application. Once they have approved the loan, they give the borrower the money. These funds come from a specialized line of credit called a “warehouse line.” After close of escrow, the bank sells the loan to an investor. The investor (e.g. Fannie Mae or Freddie Mac) pays a premium for the loan—in other words, they pay more than the face amount of the loan. The bank uses part of the proceeds to pay off the warehouse line to free it up for funding another loan. The rest goes to pay salaries and overhead and make a small profit.
The price the investor pays for a loan varies according to market conditions; it changes every day. Lenders know what they will be able to sell each loan for, and set their daily rates accordingly.
If the price the investor is willing to pay for a mortgage rises by .25% (that would be $25.00 per $1,000), the lender will be able to charge a slightly lower rate for the mortgages on that day and earn the same margin. An increase of .25% in the price of the mortgage is the equivalent of a decrease of approximately 1/16% in the rate of the loan.
Do low rates put a lid on lending?
The bank does not care what the mortgage rates are—not one bit. The bank sets its rates based on the prices the investor (Fannie Mae or Freddie Mac) pays for the loan. The margin—the “markup” on each loan they sell—remains essentially constant regardless of the rates in the marketplace.
How about the high credit standards?
Journalists claim that mortgage credit standards are very tight based on information from researchers: that the average credit score for conventional mortgages is currently 754. This is a very high score; a perfect score is 850. They conclude from this that lenders require such high scores.
That conclusion is false. The minimum permissible credit score for conventional loans has been 620 for several years, so it is far more likely that potential applicants with lower scores do not apply because they fear being rejected. Those with higher scores believe they have a better chance at approval, so they take the chance and apply.
This is why this prevailing narrative is so damaging. Borrowers with imperfect credit histories and less than a 20% down payment simply do not apply. After all: who wants to get rejected?
There are other incorrect assumptions in circulation. This has to do with how much loan a borrower can qualify for. A borrower qualifies for a loan based on his or her debt-to-income ratio (DTI). The lender calculates this important number by adding up the housing expense (including taxes and insurance) and all monthly debt payments.
Dividing this number by the borrower’s gross monthly income gives a percentage: the DTI. If the housing expense is $2,000 and other debt is $475, the total debt is $2,475. If the borrower’s income is $5,500, the DTI is 45%. Some articles have claimed that reducing the DTI as far as possible by paying off more debt will get a “better deal,” but this, too, is incorrect. Reducing consumer debt is a very good idea, but it will not improve the terms of a borrower’s loan.
What should you do now?
Many aspiring homebuyers in Seattle and all over the country are sitting on the sidelines watching home prices increase. They know their situation is not perfect, and their hopes fade with the rising prices. If you are in this group, you should act—now. Here are the actions you should take today, while this is fresh in your mind:
- Know your credit status. You can get a free credit report by going to a site like freecreditreport.com or creditkarma.com. If there are collections or liens on your credit report, deal with them now. If there are errors on your credit report, get them corrected as soon as possible.
- Gather your financial documents: two years tax returns, a current month’s pay stubs and a bank statement showing where you’ll get your cash to buy.
- Make an appointment with a loan officer to discuss your plans and situation. You will learn what kind of loan you can get and, if you need to work on negative items on your credit report, what steps you should take.
The truth is that getting a mortgage is more difficult today than it was before 2008. But that difficulty is not in qualifying for the loan. It is because there is a heavier burden of documentation (including a great many redundant disclosures) to move a loan application through the system.
You can do this
Getting a mortgage is NOT impossible. If home ownership is one of your dreams—especially if you are a first time home buyer in Seattle, you should waste no more time on the sidelines. Rates are low, and prices are still reasonable. A good place to start is to contact a Sammamish loan officer.
You CAN prove the journalists and pundits wrong. You CAN make home ownership a reality.
Just take the first step.