Tag Archives: FICO

The Future of Homeownership

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Brooklyn Law Notes - Fall 2018I wrote a short article, Restoring The American Dream, for Brooklyn Law Notes. It is based on my forthcoming book on federal housing finance policy. It opens,

Two movie scenes can bookend the last hundred years of housing finance. In Frank Capra’s It’s a Wonderful Life (1946), George Bailey speaks to panicked depositors who are demanding their money back from Bailey Bros. Building and Loan. This tiny thrift in the little town of Bedford Falls had closed its doors after it had to repay a large loan and temporarily ran out of money to return to its depositors. George tells them:

You’re thinking of this place all wrong. As if I had the money back in a safe. The money’s not here. Your money’s in Joe’s house…right next to yours. And in the Kennedy house, and Mrs. Macklin’s house, and a hundred others. Why, you’re lending them the money to build, and then, they’re going to pay it back to you as best they can.

Local lenders lent locally, and local conditions caused local problems. And in the early 20th century, that was largely how Americans bought homes.

In Adam McKay’s movie The Big Short (2015), the character Jared Vennett is based on Greg Lippmann, a former Deutsche Bank trader who made well over a billion dollars for his employer betting against subprime mortgages before the market collapse. Vennett demonstrates with a set of stacked wooden blocks how the modern housing finance market has been built on a shaky foundation:

This is a basic mortgage bond. The original ones were simple, thousands of AAA mortgages bundled together and sold with a guarantee from the U.S. government. But the modern-day ones are private and are made up of layers of tranches, with the AAA highest-rated getting paid first and the lowest, B-rated getting paid last and taking on defaults first.

Obviously if you’re buying B-levels you can get paid more. Hey, they’re risky, so sometimes they fail…

Somewhere along the line these B and BB level tranches went from risky to dog shit. I’m talking rock-bottom FICO scores, no income verification, adjustable rates…Dog shit. Default rates are already up from 1 to 4 percent. If they rise to 8 percent—and they will—a lot of these BBBs are going to zero.

After the whole set of blocks comes crashing down, someone watching Vennett’s presentation asks, “What’s that?” He responds, “That is America’s housing market.” Global lenders lent globally, and global conditions caused global and local problems. And in the early 21st century, that was largely how Americans bought homes.

 

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Can I Refinance?

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photo by GotCredit.com

LendingTree quoted me in Can I Refinance? Refinance Requirements for Your Mortgage. It opens,

While there are many reasons to refinance a mortgage, one of the biggest factors at play is whether or not you’ll be able to get a better interest rate. When interest rates drop, homeowners are incentivized to refinance into a new mortgage with a lower rate and better terms because it can potentially save them a boatload of money over the course of their loan.

Not only can refinancing save money on interest payments, but it can lead to lower monthly payments, or be a way to get rid of a pesky primary mortgage insurance requirement once you’ve earned enough equity in your home. Homeowners can also tinker with their repayment timeline when they refinance, choosing to lengthen their loan term or even shorten it to pay off their home faster.

The first question before you refinance your mortgage is simple: Does it make financial sense? Refinancing a mortgage comes with the same closing costs and fees as a regular mortgage, so you must stand to earn more by refinancing than you’ll pay to do it.

If you’ve had the same mortgage rate since the aughts or earlier, chances are you could have much to gain by refinancing in today’s lower rate environment.

The average interest rate on a 30-year, fixed-rate mortgage hit a low point of 3.31% on Nov. 21, 2012 and hasn’t budged all too much since then. Rates currently stand at 4.32% as of Feb. 8, 2018. By comparison, rates were routinely in the double digits in the 80s and early 90s.

Will rates continue on the upward trend? Unfortunately, nobody knows. But rate behavior will very likely play a key role in your decision.

Once you’ve decided refinancing makes financial sense, the next question should be this: What does it take to qualify? That’s what we’ll cover in this guide.

If you hope to refinance before rates climb any further, it’s smart to get your ducks in a row and find out the refinance requirements for your mortgage right away. Keep reading to learn the minimum requirements to refinance your mortgage, how your credit score may come into play and what steps to take next.

Can you refinance your home?

Lenders consider three main criteria when approving consumers for a home refinance – income, equity, and credit.

  • Debt and income.
  • Equity. Equity is important because lenders want to confirm possibly getting their money back out of your home if you default on your mortgage.
  • Credit. Any lending situation will involve a credit check. “They look at your credit score to see if you have the willingness to pay your mortgage back – to see if you’re creditworthy,” said David Reiss, Professor of Real Estate Law at The Center for Urban Business Entrepreneurship at Brooklyn Law School. “Do you have a low credit score or a high credit score? Do you pay your bills on time?” he asked. “These are all things your lender needs to know.”

While the above factors play a role in whether you’ll qualify to refinance your home, lenders do get fairly specific when it comes to how they gauge your income to determine affordability. Since the amount of income you need to qualify for a new mortgage depends on the amount you wish to borrow, lenders typically use something called “debt-to-income ratio” to measure your ability to repay, says Reiss.

Your debt-to-income ratio (DTI)

During the underwriting process for a conventional loan, lenders will look at all the factors that make them comfortable extending you a loan. This includes your income and your debt levels, says Reiss. “Debt-to-income ratio is an easy way for lenders to determine if you have too many debt payments that might interfere with your home mortgage payment in the future.”

To come up with a debt-to-income ratio, lenders look at your debts and compare them with your income.

But, how is your debt-to-income ratio determined? Your debt-to-income ratio is all of your monthly debt payments divided by your gross monthly income.

In the real world, someone’s debt-to-income ratio would work something like this:

Imagine one of your neighbors has a gross monthly income of $4,000, but they pay out $3,000 per month toward rent payments, car loans, child support, and student loans. Their debt income ratio would be 75% because $3,000 divided by $4,000 is .75.

Reiss says this factor is important because lenders shy away from consumers with debt-to-income ratios that are considered “too high.” Generally speaking, lenders prefer to loan money to borrowers with a debt-to-income ratio of less than 43% but 36% is ideal.

In the example above where your neighbor has a monthly gross income of $4,000, this means he or she may have to get all debt payments down to approximately $1,700 to qualify for a mortgage. ($1,700 divided by $4,000 = .425 or 42.5%).

There are exceptions to the 43% DTI rule, according to the Consumer Financial Protection Bureau. Some lenders may offer you a mortgage if your debt-to-income ratio is higher than 43%. Situations, where such mortgages are offered, include when a borrower has a high credit score, a stellar record of repayment or both. Still, the 43% rule is a good rule of thumb to follow when it comes to traditional mortgages.

Other financial thresholds

If you plan to refinance your home with an FHA mortgage, your housing costs typically need to be less than 29% of your income while your total debts should be no more than 41%.

However, the U.S. Department of Housing and Urban Development, which oversees FHA loans, also notes that potential borrowers with lower credit scores and higher debt-to-income ratios may need to have their loans manually underwritten to ensure “adequate consideration of the borrower’s ability to repay while preserving access to credit for otherwise underserved borrowers.”

Mortgage broker Mark Lewin of Caliber Home Loans in Indiana even says that in his experience, individuals with good credit and “other compensating factors” have secured FHA loans with a total debt-to-income ratio of 55%.

Of course, those who already have an FHA loan may also be able to refinance to a lower rate with no credit check or income verification through a process called FHA Streamline Refinancing. Your debt-to-income ratio won’t even be considered.

A VA loan is another type of home loan that has its own set of debt-to-income requirements. Generally speaking, veterans who meet eligibility requirements for the program need to have a debt-to-income ratio at or below 41% to qualify. However, you may be able to refinance your home with an Interest Rate Reduction Refinance Loan from the VA if you already have a VA loan. These loans don’t have any underwriting or appraisal requirements.

Equity requirements

Equity requirements to refinance your mortgage are typically at the sole discretion of your lender. Where some home mortgage companies may require 20% equity to refinance, others have much lighter requirements.

To find out what your home is worth and how much equity you have, you typically need to pay for a home appraisal, says Reiss. “Appraisals are typically required because you have to be able to prove the value of your home in order to refinance, just like you would with a traditional mortgage.”

There are a few exceptions, however. Mortgage refinancing options that may not require an appraisal include:

  • Interest Rate Reduction Refinance Loans from the VA
  • FHA Streamline Refinance
  • HARP (Home Affordable Refinance Program) Mortgages

Explaining loan-to-value ratio, or LTV

Loan-to-value ratio is a figure determined by assessing how much you owe on your home in relation to its value. If you owe $80,000 on a home worth $100,000, for example, your LTV would be 80% and you would have 20% equity in your home.

This ratio is important because it can determine whether your lender will approve you for a refinance. It can also determine the interest rates you’ll pay and other terms of your loan. If you have less than 20% equity in your home, for example, you may face higher interest rates and fees when you go to refinance.

Having less than 20% equity when you refinance may also cause you to have to pay PMI or private mortgage insurance. This mortgage insurance usually costs between 0.15 to 1.95% of your loan amount each year. If you have less than 20% equity in your home already, you’re already likely to be paying for this coverage all along. However, it’s still worth noting that, if you refinance with less than 20% equity, this coverage will once again get tacked onto your mortgage amount.

Is 80% LTV mandatory?

Your LTV and equity aren’t the end-all, be-all when it comes to your loan refi application. In fact, Reiss says that lenders he has experience with don’t absolutely require borrowers to have 20% equity or a loan-to-value ratio of 80% — so long as they score high on other measures.

“If you meet the lender’s requirements in terms of income and credit, your loan-to-value ratio doesn’t matter as much — especially if you have excellent credit and a solid payment history,” he said. However, lenders do prefer lending to consumers who have at least 20% equity in their homes.

Reiss says he always refers to 20% equity as the “gold standard” because it’s a goal everyone should shoot for. Not only does having 20% equity in your home when you refinance help you avoid paying for the added expense of PMI, but it can help provide more stability in your life, says Reiss: “Divorce, disease, and death in the family can and do happen, but having equity in your home makes it easier to overcome anything life throws your way.”

For example, having more equity in your home makes it easier to refinance into the best rates possible. Having a lot of equity is also ideal when you have to sell your home suddenly because it means you’re more likely to turn a profit and less likely to take a loss. Last but not least, if you have plenty of equity in your home, you can access that cash for emergency expenses via a home equity loan or HELOC.

“Home equity is a big source of wealth for American families,” he said. “The more equity you have, the more resources you have.”

Fortunately, many households are enjoying greater home equity today, as home values have continued to increase since the housing crisis.

Your credit score

The third factor that can impact your ability to refinance your home is your credit score. When a lender decides whether to give you a mortgage or not, they typically offer the best rates to people with very good credit, or with FICO scores of 740 or higher, according to Reiss.

“The lower your credit score, the higher your interest rate may be,” he said. “If your credit score is bad enough, you may not be able to refinance or get a new mortgage at all.”

The FICO scoring model’s main website, myFICO.com, seems to echo Reiss’ comments. As it notes, a “very good” score is any FICO score in the 740-799 range. If you earn a 740+ FICO, you’re above the national average and have a greater likelihood of getting credit approval and being offered lower interest rates.

Don’t stress about getting a perfect 850 FICO score either. In reality, rates stop improving much once you pass 740.

Understanding Homeownership

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The Housing Finance Policy Center at the Urban Institute released its House Finance at a Glance Chartbook for December. It states that financial education “can help reduce barriers to homeownership.” As I argue below, I do not think that financial education is the right thing to emphasize when trying to get people to enter the housing market.

The Introduction makes the case for financial education:

While mortgage debt has been stable to marginally increasing, other types of debt, particularly auto and student loan debt have increased far more rapidly. Our calculations, based on The Federal Reserve Bank of New York’s Quarterly Report on Household Debt and Credit, show that over the past 5 years (Q3 2012 to Q3 2017), mortgage debt outstanding has grown at an annualized rate of 1.3 percent, while non-mortgage debt (which includes credit card debt, student loan debt, auto debt, and other debt) has grown by 6.8 percent annualized rate. Student loan debt has grown by 7.3 percent per year while auto debt has been growing by 9.6 percent per year. In Q3 2012, the number of accounts for mortgage loans and auto loans are very close (84 million vs 82 million). By Q3 2017, the number of accounts for mortgages had fallen to 80 million consistent with declining homeownership rate, while the number of accounts for auto loans had increased to 110 million.

Another metric where auto loans have diverged from mortgages is delinquency rates. Over the past 5 years, mortgage delinquencies have plummeted (pages 22 and 29) while the percent of auto loans that is more than 90 days late is roughly flat despite an improving economy. However, the percent of auto loans transitioning into serious delinquency has risen from 1.52 percent in Q3 2012 to 2.36 percent in Q3 2017. While these numbers remain small, the growth bears monitoring.

When we looked at the distribution of credit scores for new auto origination and new mortgage origination, we found no major change in either loan category; while mortgage credit scores are skewed higher, the distribution of mortgage credit scores (page 17) and the distribution of auto credit scores have been roughly consistent over the period. Our calculations based off NY Fed data shows the percent of auto loan origination balances with FICOs under 660 was 35.9% in Q3, 2012, it is now 31.7%; similarly the percent of auto origination with balances under 620 has contracted from 22.7 percent to 19.6 percent. There have been absolutely more auto loans with low FICOs originated, but this is because of the increased overall volume.

So what might explain the differences in trends in the delinquency rate and loan growth between these two asset classes? A good part of the story (in addition to tight mortgage credit) is that many potential low- and moderate-income borrowers do not believe they can get a mortgage. As a result, many don’t even bother to apply. We showed in our recently released report on Barriers to Accessing Homeownership that survey after survey shows that borrowers think they need far bigger down payments than they actually do. And there are many down payment assistance programs available. Moreover, it is still less expensive at the national level to own than to rent. This suggests that many LMI borrowers who are shying away from applying for a mortgage could benefit from financial education; with a better grasp of down payment facts and assistance opportunities, many of these families could be motivated to apply for mortgages and have the opportunity to build wealth. (5)

I am not sure if financial education is the whole answer here. Employment instability as well as generalized financial insecurity may be playing a bigger role in home purchases than in car purchases. The longer time horizon as well as the more serious consequences of a default with homeownership may be keeping people from stepping into the housing market. This is particularly true if renters have visions in their heads of family members or friends suffering during the long and lingering foreclosure crisis.

Mortgage Pre-Qualification vs. Pre-Approval

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photo by Steve Spinks

Realtor.com quoted me in Mortgage Pre-Qualification vs. Pre-Approval: What’s the Difference? It opens,

When buying a home, cash is king, but most folks don’t have hundreds of thousands of dollars lying in the bank. Of course, that’s why obtaining a mortgage is such a crucial part of the process. And securing mortgage pre-qualification and pre-approval are important steps, assuring lenders that you’ll be able to afford payments.
However, pre-qualification and pre-approval are vastly different. How different? Some mortgage professionals believe one is virtually useless.

“I tell most people they can take that pre-qualification letter and throw it in the trash,” says Patty Arvielo, a mortgage banker and president and founder of New American Funding, in Tustin, CA. “It doesn’t mean much.”

What is mortgage pre-qualification?

Pre-qualification means that a lender has evaluated your creditworthiness and has decided that you probably will be eligible for a loan up to a certain amount.

But here’s the rub: Most often, the pre-qualification letter is an approximation—not a promise—based solely on the information you give the lender and its evaluation of your financial prospects.

“The analysis is based on the information that you have provided,” says David Reiss, a professor at the Brooklyn Law School and a real estate law expert. “It may not take into account your current credit report, and it does not look past the statements you have made about your income, assets, and liabilities.”

A pre-qualification is merely a financial snapshot that gives you an idea of the mortgage you might qualify for.

“It can be helpful if you are completely unaware what your current financial position will support regarding a mortgage amount,” says Kyle Winkfield, managing partner of O’Dell, Winkfield, Roseman, and Shipp, in Washington, DC. “It certainly helps if you are just beginning the process of looking to buy a house.”

Minority Homeownership During the Great Recession

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photo by Daniel X. O'Neil

Print by Andy Kane

Carlos Garriga et al. have posted The Homeownership Experience of Minorities During the Great Recession to SSRN. The paper concludes,

The Great Recession wiped out much of the homeownership gains attained during the housing boom. However, the homeownership experience was very different across racial and ethnic groups. Black and Hispanic borrowers experienced substantial repayment difficulties that ultimately led to a greater share of homes in foreclosure.

Given that home equity often represents a substantial share of household wealth, these foreclosure events severely damaged the balance sheets of minority families. The dynamics of delinquency and foreclosure functioned differently across the income distribution within racial and ethnic groups.

For the majority, higher income was associated with lower delinquency rates and fewer foreclosures as a group. However, for Hispanic families this relationship was surprisingly reversed. Hispanics with the highest incomes fared worse than those with the lowest incomes. This counterintuitive finding suggests how college-educated Hispanic families may have had worse wealth outcomes than their non-college-educated peers: Hispanic families with high income (potentially the result of high educational attainment) had a greater share of home equity lost in foreclosure than lower-income Hispanic families.

Logit regressions suggest that underwriting standards and loan structure explain a significant amount of the greater likelihood of foreclosure among Black and Hispanic borrowers. However, underwriting standards explained more of the gap for Black borrowers, while loan structure was a stronger factor among Hispanic borrowers. Regional concentration and variation in housing markets explained more of the Hispanic-White foreclosure gap than any other group. This is understandable given that Hispanic borrowers in our sample were heavily concentrated in housing markets that experienced some of the largest volatility. Despite accounting for these important factors, sizable gaps remain in foreclosures among Blacks and Hispanics relative to Whites. Incorporating measures of labor market outcomes into the analysis may offer further insights.

In sum, the homeownership experience during the Great Recession proved to be inimical for many families, but far more so for Black and Hispanic families. For these families, financially destructive foreclosure events delayed and potentially derailed the dream of homeownership. (164-65)

I am not sure what this all means for housing finance policy other than the obvious: consumer protection in the mortgage market is a good thing as it ensures that underwriting standards evaluate ability-to-repay and loan structures exclude abusive terms like teaser rates (thanks to the ATR and QM rules and the Consumer Financial Protection Bureau). There are probably other policies that we should consider to reduce the depths of our busts, but they do not seem likely to gain traction in the current political environment.

No-Credit-Check Loan Red Flags

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photo by Rutger van Waveren

OppLoan quoted me in 6 No Credit Check Loan Red Flags. It opens,

Welp. A kid just threw a baseball through your window and ran away before you could get his parents’ information. Now you need a loan to fix it. But what if your credit score isn’t exactly a home run? What are you going to do now?

It’s a fact of modern life: a “good” credit score (a FICO score of 680 or higher) can make little financial emergencies like these much more bearable. Unfortunately, just over half of American consumers have weak or bad credit. According to credit expert David Hosterman of Castle and Cooke Mortgage (@CastleandCooke), “Customers with bad credit can have trouble financing a home, renting a home, obtaining credit cards, car loans, student loans, and more.” And it’s not a problem that goes away overnight. Hosterman says rebuilding credit can “sometimes take years to complete.”

So how can people with bad credit get a loan if an urgent need arises? One option is a “no credit check” loan. And if these loans sound too good to be true, it’s because they often are. Many “no credit check” loans are nothing more than financial traps designed to suck away as much of your paycheck as possible. Keep an eye out for these red flags before you end up in a very bad situation.

1. They Don’t Care About Your Income

Lenders see a bad credit rating and take it as a sign that a potential borrower might never pay them back. That’s why a good “no credit check” lender will make sure that you have a source of income—so they know they’ll get their money back eventually.

But not every “no credit check” lender will check your income. So how do they know you’ll pay it back? They don’t. In fact, it’s worse than that. They’re expecting you not to. Because if you can’t pay your loan in time, you’ll be forced to roll it over and pay an additional fee to extend it. These predatory practices are often associated with payday lenders, because you could end up having to turn over your paycheck as soon as you get it to pay back the loan. That doesn’t leave much money for luxuries like rent, so you could find yourself having to take out another loan or pay to extend the first one. This can easily trap you in a dangerous cycle, having to continually rollover your loan without any hope of paying it off. You want to avoid this situation at all costs.

2. Short Payment Terms

Any good lender wants you to have a real shot at actually paying back your loan in full. A bad lender, on the other hand, wants you to be trapped into rolling over your loans so that you can give them money forever. They’ll require you to pay back the entire loan, with interest, after only a few weeks—and sometimes less!

Instead, find a lender that will offer you an installment loan. David Bakke (@YourFinances101), a finance expert at MoneyCrashers.com, says that one of the main benefits of installment loans is that they “usually come with fixed interest rates, meaning that you know what your monthly payment is going to be.” A good “no credit check” lender will be certain that you have a source of income and then work with you to create a repayment plan that you can handle.

3. They Talk About Interest Rates Instead of APR

APR stands for Annual Percentage Rate. According to David Reiss (@REFinBlog), a law professor and editor of REFinBlog.com, the APR number shows the total cost of a loan, including fees and interest. Reiss points out that APRs allow potential borrowers to make an “apples-to-apples” comparison between loans. It gives you a full and clear picture of how expensive a loan really is. In other words, it’s a number that many “no credit check” lenders would prefer you never see.

They’d rather show you a basic interest rate, even though federal law requires APRs be used in most cases. Not only can that hide all sorts of fees, but it forces you to do some pretty complex math if you want to actually know how much you’ll be expected to pay. Friends never make friends do complex math problems, so if a lender isn’t talking in terms of APR, they’re likely not your friend.

Foreclosure or Short Sale?

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photo by Taber Andrew Bain

BeSmartee.com quoted me in Which One Is Worse: Foreclosure or Short Sale? It opens,

If you’re faced with either a foreclosure or a short sale situation and aren’t sure what to do, read on. We asked some experts which one is worse.

You might have thought that you became a homeowner the day you closed on your home, but that wasn’t exactly the case. Although your status became ”homeowner” as opposed to, maybe, ” renter ,” you don’t really own the home if you have a mortgage. A more accurate term for what you became that day would be ”home borrower.” This isn’t just being picky about semantics. There’s a reason for the distinction.

If you stop paying your mortgage , the real owner of the home, your mortgage lender, could take it back. This process is a foreclosure .

Another option that may be available to you if you can no longer (or no longer wish to) make your mortgage payments is a short sale . A short sale occurs when you sell your home for less than what you owe. Your lender must be on board with this for it to happen.

So which one is worse: foreclosure or short sale? Here are five considerations.

1. Your Credit Score

Your credit score will take a hit, and a huge hit at that, whether you have a foreclosure or short sale on your credit report. ”They are pretty much equally rotten as far as your credit score is concerned,” says David Reiss , professor of law at Brooklyn Law School.

But just how rotten are foreclosures and short sales to your credit? You can probably count on your score tanking somewhere between 100 and 160 points. And like the saying, ”The bigger they are the harder they fall,” the higher your credit score was before the foreclosure or short sale the larger the drop will be. But the good news is that with either a foreclosure or a short sale, you can start to see your score rise in just a couple of years if you continue to pay all your other bills on time, according to myFICO , the consumer division of FICO .

2. What Future Lenders Think

If you wish to get back into the housing game some day, whether you went through a foreclosure or a short sale matters to many lenders. ”There’s not as much of a stigma involved in selling a house via short sale as there is in losing it in a foreclosure proceeding,” says Rick Sharga, chief marketing officer at Ten-X, an online real estate transaction marketplace. ”A short sale indicated that the borrower was willing to work with the lender, and in fact, an active participant in trying to come up with a solution that worked as well as possible for all parties.”

” Fannie Mae and Freddie Mac treat a foreclosure as worse than a short sale when it comes to future lending,” says Reiss. ”Fannie, for instance, won’t buy a mortgage from a lender who lent to someone who has gone through a foreclosure in the past three years in some cases (but as many as seven), but reduces that bar to two years for a short sale.”