The Screws Are Turning

Even those who are not close to the mortgage business can't help but see all the newspaper articles about subprime lending. The various branches of our government are weighing in on the problems that are happening as a result of the lax underwriting. We've seen the posturing statements by the Congress's Committee Chairmen.  However, not much concrete has happened until this week. We are finally seeing some action in the trenches.

FannieMae has announced that it will comply with new guidelines issued by a consortium of agencies. The rest of the industry will likely follow. These guidelines include:

All fixed rate interest-only loans will be underwritten using the fully amortized payment, not just the interest portion. For example an application for a $200,000 6.5% loan would be underwritten with the payment of $1,264, not just the interest portion, $1,083. That's 16.7% higher, which means that qualifying ratios are affected. A borrower who had ratios of 36% before would have ratios of 40% now.

All interest only ARMs will be underwritten using the fully amortized payment at the fully indexed rate. The initial rate on a 5/1 ARM, for example, might be 6%. The initial interest-only payment would be $1,000 but if index plus margin is 7.5%, the borrowers would have to qualify for a payment of $1,398, 40% higher.

Option ARMs, the negative amortizing loans, must be underwritten as above AND the payment has to be based upon a loan balance of 115% of the initial loan. Thus a $200,000 loan would have to be underwritten assuming that it was really a $230,000 loan. Using a figure of index plus margin equal to 7.5%, that means the payment would be $1,608, a full 60% higher than the initial payment.  If some lender is discounting that initial payment rate even further, VERY likely the case, it means that the payment for underwriting purposes might be double the actual obligatory initial payment.

No one knows exactly what the full implications are going to be, but for many borrowers who are at the borderline for qualifying purposes are going to be disappointed. It is likely that the number of Option ARMs that have been originated in the recent past, as many as 50% of all loans in some markets, are going to see drastically reduced volume.

There are going to be further restrictions on stated income loans. Those lenders who told their borrowers who can't qualify to lie about their income will have that option taken off the table except for borrowers with very strong credit.

Finally, there are many lenders whose oversight does not lie with these agencies.  In fact, it's not clear exactly who DOES regulate them, meaning who did let them get away with poor practices?  If they don't sell loans to FannieMae and the investors who buy the loans don't adopt the same rules, there will be little change. Not a good sign.

Randy Johnson – Author of How to Save Thousands of Dollars on your Home Mortgage and Savvy Borrower articles. Randy is a mortgage broker who has financed over $1 billion in properties. He writes about home buying and real estate finance topics for CreditBloggers.com.