Do You Think Your Client is Pre-Approved for a Loan? Better Think Twice.
You may have been reading lately about the troubles of one of the nation’s largest sub-prime mortgage lenders, New Century Financial Corp. This once ‘high-flying’ company was trading over $50 per share last summer, but has now been de-listed by the New York Stock Exchange and was trading for less than $1 last week. It seems they are headed for bankruptcy.
Sub-prime loans target people who have troubled credit histories and/or low down payments. Concern about the sub-prime mortgage market is one of the factors that led to the drop in the stock market on February 27th. The question is – how does this impact me, my clients, and our marketplace?
As you know, lenders have aggressively been lending mortgage money over the past several years. When property values were increasing significantly, the risk was relatively low. As homes appreciated and homeowners gained equity, they would do whatever was necessary to make their payments and protect their equity. If a borrower experienced financial difficulty or could not make their payments for some reason, they could likely refinance or sell for a profit. The homeowner walked away with money in their pockets and the lender got their money back. Everybody won.
Now – fast forward 12-18 months and times have changed. Many of the sub-prime loans that were originated over the past few years were 2/28s or 3/27s. This meant the loan had a fixed rate for only the first two or three years. Quite often there was a pre-payment penalty that mirrored the fixed rate period. So a 2/28 mortgage would have a rate fixed for two years and a two year pre-payment penalty. And when sub-prime loans adjust, they are likely to adjust to a much higher rate than a standard adjustable rate mortgage (sometimes 5-7% higher). So the plan was that immediately after the two year pre-payment penalty expired, and right when the payment was going to adjust, the borrower would refinance into a better loan using the equity that had accumulated in their homes. If the homeowner’s credit was bad when the home was purchased, then they probably thought the credit would improve over the next two years, allowing them to get even better terms on the refinance loan in the future. Many lenders even called these 2/28s or 3/27s ‘Band-Aid’ loans. They were designed to get the buyer into the home, but not designed to carry the buyer through the term they planned on owning the home.
Now we arrive at the kink in the plan. Many homes purchased two or three years ago are not worth what the buyers paid for them – or perhaps have increased only slightly. If the poor credit that existed when the home was purchased has not been cleaned up over the past two years, then the homeowner is likely in a worse position than they were when they purchased the home. And because sub-prime lenders are experiencing an increase in their default rates, the industry is becoming more restrictive in their guidelines for sub-prime lending. So if a homeowner has poor credit, no equity, and their loan is adjusting to a payment they cannot afford, what do they do? The options are not pretty.
This tightening of credit standards has the potential to impact many people. Reduced documentation loans, popular among the self-employed or others whose income is difficult to document, are getting harder to get. Credit score thresholds for these loans are increasing, as are the required down payments. Even low or no down payment loans for those with full documentation and perfect credit are being affected. At least one large national retail/wholesale lender seems to have deliberately priced itself out of the 80/20 loan business. Lenders are seeing loans they could do yesterday disappear today. Ironically, rates for those with good credit and documented income are actually dropping right now due to the dynamics of our financial markets and how investors are investing in our bond markets.
What does this mean to you and your clients? If you have a client with less than perfect credit or non-traditional income documentation, encourage them to get pre-approved as quickly as possible. However, be cautious – it is possible the loan program that was used to pre-approve your client could change prior to closing. This is unlikely, but it is happening. Your title or escrow companies probably have experienced loans falling apart immediately before closing over the past couple of weeks. Builders are also likely to tell you that they have clients who have been pre-approved for many months scramble to find a new loan because the program they were planning on using has been eliminated.
Many Realtors do not like to micromanage the loan process; they simply trust the mortgage lender to do their job. This is a good thing, provided the communication lines with the lender are open. If the lender your client is using has not had a pro-active discussion with you about the changing market, you should open that dialogue with them. Many traditional loan programs are not impacted at all by these changes; other are changing daily. If you are representing a seller, it also seems reasonable that you should get a bit more involved in the financing of a prospective buyer. If you are told they are doing a reduced documentation loan and/or a low down payment, it is prudent to ask some questions of the lender and assess their credibility.
Whether or not this will impact property values remains to be seen. My concern is not the people that cannot get a new loan to purchase a home. By some accounts, this could only be 2-3% of prospective buyers. In my opinion, a bigger concern is how many people who are in sub-prime loans now will no longer be able to afford them when they adjust and have no good refinance or sale opportunities. Also alarming is that the sub-prime concerns seem to be spilling over into the ALT-A market segment. This would affect those buyers who would like to do an 80/20 loan or those buyers with perfect credit, but need reduced documentation.
This is the time to be sure your lender is actively managing their pipeline. An individual loan originator has no control over loan guidelines or interest rate changes, but it is important the possibilities of such changes are communicated to the clients that could be impacted. If you are unsure of whether or not your client is working with a true mortgage professional, you should have a conversation with the lender and check for yourself. My partner and I have some talking points posted to our website you may find useful – How do you know you’re working with a Professional?
As always, the changes our industry is undergoing will allow the best real estate professionals to rise to the top. Now it is more important than ever to be your clients’ trusted advisor.
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About the Author: Andy Mersiowsky, CMPS is a mortgage banker with Valley Private Mortgage Group, Inc. located in Scottsdale, Arizona. He is licensed to lend in all 50 states and has worked with The Messenger Team (Jim & Andrea) for several years. We want to thank Andy for providing great mortgage services to our clients over the years, and we welcome his input as a FamousAuthor on our blog. For more information, please visit www.theamtgroup.com
-Jim & Andrea Messenger
Andy, thanks for an excellent review of how lending practices are changing.
Realtors… this is an excellent marketing opportunity for you. If you have any buyers on the fence that may be self-employed, considering an 80/20 loan, or otherwise not a perfect fit for traditional loans, now is the time to tell them to get approved and buy.
It may be their last chance to get the loan they need at a decent rate – or at any rate, for that matter.
March 22nd, 2007 at 9:12 pmAndy,
How many of the investors that you work with have dropped 80/20s and Stated Income from their product lines?
Any big name lenders making these type of changes?
March 22nd, 2007 at 9:29 pmAndy – Great article.
The point you made about when a borrower got into financial difficulty they would refinance or sell. Really hits human nature – habit. We as humans are extremely comfortable with our habits – for the high risk borrower – their habit is poor personal financial management skills. This aspect was overlooked through the equation of assessing or assigning risk to a loan.
Another aspect of human nature that may have been greatly overlooked is the need for shelter. Some think “who wants to lose their home?” The error here is that shelter can be replaced – renting or moving in with relatives or friends. Without a vested interest in the property.
What are your thoughts on these aspects?
March 23rd, 2007 at 5:44 amAndy – I forget to ask this question.
For real estate agent – how would you define a pre-approval and what should we look for in order to determine the amount of reliance that we can place on a pre-approval?
Thanks
March 23rd, 2007 at 5:46 amGlenn –
Your question about pre-approvals is a good one. I would define a pre-approved loan as a loan that has been underwritten and approved.
As you know, many loans are approved these days through automated underwriting systems. Once approved by an AUS, the human underwriter will review the automated approval and verify any conditions required are in the file AND verify that the information that was used to obtain the automated approval is accurate. This is where mistakes can happen. The loan officer must have the ability to understand different forms of income, what is qualifiable income, what assets can be documented, and the ability to spot other potential trouble issues. It all comes down to the credibility and trust you have with your lender.
In short – if you are not using a lender you have that level of trust with, I would suggest you receive in writing confirmation that the credit has been pulled, the loan has received some kind of underwriting, that the client has provided the documentation the approval requires, and that the client is comfortable with the payment and estimated cash-to-close.
You may feel comfortable working with a client without all of this, but having the above information should definitely make you feel more secure.
March 26th, 2007 at 11:02 amJim – to reply to your questions about product changes: yes, big-name lenders are making product changes.
Many lenders have changed guidlienes as they pertain to stated-income and 80/20s – the biggest names in our industry. Whether or not the pendulum is swinging too far remains to be seen.
I suspect once everyone truly understands their exposure to bad loans, we will see things loosen-up a bit for the better borrowers.
March 26th, 2007 at 11:10 amIn the meantime, be prepared for daily product changes.
Andy – Thank you for your response, it was exactly what I expected for answer.
March 26th, 2007 at 4:48 pmI think we are all prepared for daily changes, it’s the details of the changes that are daunting.
March 27th, 2007 at 10:36 amGary,
I would argue that most are not prepared for daily changes. I believe most don’t even know changes have occurred.
P.S. Welcome to FamousAgents.com!
March 27th, 2007 at 11:15 amInteresting about New Century. You would think that they would still be out there with all the loans and money they have made over the years.
March 27th, 2007 at 8:35 pmWith the sub prime melt down, I think we will be dealing with alot of FHA loans and the “gift” type programs have been waiting for this day.
March 27th, 2007 at 8:37 pmThe Realtor needs to work with a lender whom they trust. So when the lender says the clients are “pre approved” then that is exactly so. Too many lenders in the past pre approved their clients without any paperwork, etc. We are headed for a normal type market now. Everyone will have to work at their profession now whether it is real estate or lending.
March 27th, 2007 at 8:41 pmThe changes will be drastic at first, even for good credit borrowers. Then over time things will start to lax again. This isn’t the first this has happened and it isn’t the last.
March 28th, 2007 at 4:54 pmThe way things are changing over night, seems like you have to check everyday to make sure your client is still approved………
March 29th, 2007 at 5:22 pmLooks like we will see alot of FHA loans now.
March 29th, 2007 at 5:23 pmYour so Correct-o Shelly!
I have been so busy in the last few weeks- with loans coming in from all over the nation and all types of special situations- I have been saving realtors loans left and right from other “non-seasoned” loan officers; it’s crazy!
March 30th, 2007 at 2:54 pmGary – could you explain some of the detail changes that are taking place?
I know one client that had been approved for a loan program, is now not qualified for that program.
Any one else seeing this happen?
BTW – Andy – your article is what inspired me to have him check on his pre-approval.
April 1st, 2007 at 7:14 amKen – the changes although drastic are probably very logical and may get back to normalcy. Sometimes I have to wonder if the relaxation of the loan programs was something that was done to keep the economy from going into recession. After all, the housing market was pumping up the economy for many months.
April 1st, 2007 at 7:17 amGiorgio – glad to hear that you are busy with the loan business. Do you think you could share some of the loan programs that are out there, so we real estate agents could give some ideas to our buyer prospects?
April 1st, 2007 at 7:19 amShelley – finding someone to do or knows how to do an FHA loan in my area is like trying to find a needle in the haystock. All the relaxed loan programs no one over the past few years needed FHA.
I called a mortgage broker friend with a large lender and has years of experience and asked if she could do an FHA loan. Her company can do FHA loans, but she has not done one in years!
April 1st, 2007 at 7:22 amIt is also an issue in my area. Not all lenders felt the need to spend the money to get approved by FHA or deal with auditing procedures.
April 1st, 2007 at 9:03 amIt seems the lenders in my area have forgotten about FHA and their guidelines.
April 1st, 2007 at 5:50 pmEach program that I can offer nationally is really tailored to fit each borrower and their current situation.
Glenn,
Some borrowers are HNW (high net worth)professionals with 2nd/ vacation homes; some are mixed unit investments, some are multi-million dollar single family residences and/ or condos. Fast closings and happier Realtors.
In this case, everyone is truely different. I like to refer to them as ‘snowflakes,’ each individualy unique. What they can be sure of is this: Best Pricing, Best Service & Lowest Rate, Guaranteed! We are ultra competitive.
April 1st, 2007 at 7:10 pmGlenn,
FHA is a simple process; provided the borrower is in good standing, pays their bills on time and is not in any federal default. Govi loans can help get a 1st time buyer into that residence with little or no bumps and brusies.
April 1st, 2007 at 7:12 pmAndy,
Really great article! I enjoyed the PDF doc on working w/ a professional. Most of the lending community should take a page from your lending book- we would have a more happier & stable work environment.
April 1st, 2007 at 7:28 pmI appreciate the feedback on my article. I think this market will force all of us to get ‘back to the basics.’ I agree that FHA is a great outlet for many loans. I believe there are several reasons we have not seen many FHA loans over the past few years. First, the lending industry has seen a tremendous influx of originators over the past several years, many of whom have never taken the time to learn about government loans or work for brokerages that are not able to originate them. Second, the real estate market had been such a seller’s market in many places that the sellers could pick and choose which contracts they accepted. If a purchase offer came in with government financing, I believe many agents recommended against accepting it due to the connotation that FHA loans are for people with bad credit or hard to qualify buyers. Third, FHA does not offer interest-only loans – and so many of our clients were asking for them. Now we see these loans have been abused by many in our industry, so they are harder to get.
Overall, I believe the adjustments taking place are good. I dislike the almost daily rate/program changes in the ALT-A market. I hope the worst is over, but it is important to keep an eye on those pipelines. Mistakes can easily happen in this market – it is important that they be kept to a minimum.
Like Giorgio said, those of us with experience are picking up loans that have fallen-out with other lenders. Some of these are relatively easy to fix and get closed, others are more difficult because an expectation level had been set by the old company that simply can’t be met. I feel bad for those buyers, but that is what can happen when someone shops the newspaper ads or the Internet looking for the best rate quote without regards to anything else.
April 2nd, 2007 at 9:33 amAndy – I just love your comment “I feel bad for those buyers, but that is what can happen when someone shops the newspaper ads or the Internet looking for the best rate quote without regards to anything else.”
It truly spells out that borrowers are given a false sense of the lending market. For example, a self employed individual, looks for a loan over the Internet, using his gross income (1099 as the source), but does not realize that it is actually his net income from the business that is actually used when the loan application is completed.
Getting a good loan program takes time, guidance, and experience. This occurs when a TEAM approach to purchasing or refinancing takes place.
April 9th, 2007 at 5:13 amIt’s like I always say-
Much like a Doctor that sees their patient- he cannot prescribe a proper medication without diagnosing the problem areas. Want an internet rate? Your setting yourself up for the fall- rates, change and so do good faith estimates. Don’t buy into it. Each loan that I perform is similar to a snowflake; they are all distinct and differ one to the next.
April 9th, 2007 at 6:20 am