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It’s Getting Tougher to Qualify For Home Loans


Interest rates are at rock-bottom levels. As of this writing, 30-year fixed-rate home mortgages are going at interest rates of around 3.75 percent. Furthermore, Chairman of the Federal Reserve Ben Bernanke has indicated that the Federal Reserve Bank Board of Governors intends to hold rates that low through at least 2015. The idea is to make it cheap to borrow money, to stimulate economic activity and hopefully to create job growth.

But a funny thing happened on the way to the money: Lenders are starting to go on strike. Yes, interest rates are very low. But lenders are starting to become much pickier about who they lend to, according to data recently released from Ellie Mae, a mortgage-industry software company.

Why would lenders roll back on loans? Because at rates of under 4 percent, banks, credit unions and other lenders can only afford the very safest loans. If default rates pick up even slightly, it’s a money-loser for the lenders.

The Way Things Used to Be

During the heyday of the real estate boom of 2001-2006, the “FAM” rule governed mortgage lending. If you could “fog a mirror,” chances are good that someone, somewhere, would lend you the money. Increasingly, investors were able to take out loans with little or no documentation of assets or income, a spotty credit history, and little or nothing down. Some were taking out so-called NINJA loans – a humorous mortgage-industry shorthand for “no-income, no-job application.”

Lenders were banking that the property itself would adequately secure the loan. But they were wrong. Spectacularly wrong.

Fast forward to today:

According to Ellie Mae’s report, the average FICO credit score for an approved loan is now 750. That’s up a full 9 points from a year earlier.

What’s more, the average debt-to-income ratios on mortgages are much more stringent than they used to be.

Debt to Income

Your debt-to-income ratio, or DTI, in the mortgage world, reflects the percentage of your income that goes to housing or to overall debt-service. It’s measured in two different ways:

Your front-end ratio is your monthly housing expenses divided by monthly income. If you have $5,000 of income every month, and you are taking on a combined mortgage, interest, property tax and insurance burden of $1,500, your front-end ratio is .30.

Your back-end ratio is your monthly income divided by all your monthly debt-service payments. So if in addition to that housing expense, you also have $500 per month in other debt service payments, your back end ratio is $5,000 / $2,000, or .40.

For FHA loans, the maximum front-end ratio to qualify is .31, and the maximum back-end ratio to qualify is .43.

The average DTI figures on approved loans in August of 2012 is significantly lower than the max allowable FHA debt-to-income ratios. The average DTIs on approved loans for August 2012 is .23 for a front-end ratio – and .34 for a back-end ratio.

Declined Applications

But Ellie Mae went a step further with the data: They also published statistics for the average loan that was declined – which is even more instructive. If you’re closer to the declination numbers than to the approval numbers, your application could well be headed to Rejectville.

The average credit score on applications that are actually declined now is 708. And the average DTI figures on denied applications is .27 for the front-end ratio, and .43 for the back-end ratio.

Down Payments

Ellie Mae’s data specifically refers to conventional or FHA mortgages. It did not publish figures for VA mortgages. The biggest difference for VA mortgages is in the down-payment rules, though. Since the U.S. government guarantees VA loans against default, lenders can take the VA guarantee rather than rely on your down payment to secure the loan. Loans under this program don’t have to carry PMI insurance, which does nothing for the borrower, but the borrower still has to pay premiums if the value of the home is less than 80 percent of the amount borrowed.

Frequently, though, you can get a better interest rate with a substantial down payment on a conventional loan (though you give up whatever rate of return your down payment was earning somewhere else).

So leaving VA loans aside, and just looking at data for conventional and FHA new purchases, the average new approved mortgage had a loan-to-value ratio of 79 percent – just under the PMI threshold. This means that borrowers were making substantial down payments.

Borrowers putting less down have a harder time getting approved: The average LTV for a declined application was .88 – substantially higher than the approvals. Lenders are routinely turning down purchases with 10 percent down, which would equate to a LTV of .90.

Issues Specific to Veterans Administration Loans

Generally, the VA requires a debt-to income ratio (back end ratio) of .41 or lower. In some cases, if your leftover (or residual) income is 120 percent of the requirement for the amount of money you are borrowing, the VA will guarantee loans with a back-end ratio of .45. However, lenders may still decline these marginal applications – or demand a higher interest rate for the risk.

Underwriting guidelines take into account the region of the country and the size of your family.

VA loans underwriters will typically include childcare for any children under 12 under the debt column for purposes of underwriting a mortgage.

VA underwriters typically will expect a three year income history, and two years of employment verification. If you have left the workforce and are re-entering it, you should be on the job for at least six months before applying for a mortgage on your own credit. Be prepared to have a letter of explanation for any gaps in employment of one month or greater.

Educational benefits you receive from the VA don’t count towards income for VA loans (not that you can rely on them paying you on time anyway!).

Additional requirements apply for self-employed borrowers.

Tips

It’s more important than ever to maintain solid credit, and vigilantly police your credit report for false information, identity theft, and anything else that could lower your score. It’s also more critical to control debt than before.

You can get a mortgage, and even a VA mortgage, even if you have filed bankruptcy in the past. However, you must have fully discharged the bankruptcy and established new credit – or provide a reasonable explanation to underwriters why you have decided not to establish a new credit history. Other restrictions apply to those with bankruptcies.

Expect to bring all your delinquencies current or paid in full before getting a new VA loan. This is pretty much the case with all mortgages: If you can’t pay your existing bills, underwriters know you’re a bad risk for a mortgage!

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