Blown Mortgage

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What Underwriting Guidelines Would Make a Difference?

Fannie and Freddie’s lack of a disposable income test is one reason why we find ourselves in the mess that we’re in. Their “conforming” stamp of approval means that so many lenders don’t truly have to bear the all consequences of their actions. So they don’t take time to come up with guidelines that make a lot of sense. Don’t you think a local bank, forced to eat its mistakes, would come up with rules that pretty much guaranteed them that they were making mostly good loans? You betcha. By putting things in the “conforming” wrapper, people don’t see issues like yesterday’s borrower’s real world weakness.

The answer is not as simple as “cut loan to values,” and “increase documentation.” There are high LTV, high ratio loans that perform well, even in the face of today’s tsunami of defaults. If you’re making–really making–12,000 a month, is a 60% debt to income ratio going to be manageable? You bet it will. At $30,000 per year, though, “low” debt ratios like 35% can be tight with real, fixed costs to feed, clothe, and ship people off to work. What we need to do is modernize underwriting standards to allow maximum flexibility without incurring unnecessary risk. I want your suggestions, but here are mine:

1. Property/Transaction Type: For years, in Florida and Nevada, people got away with buying new construction to flip without a plan “B” if it didn’t sell. Why was this allowed? Why did anyone think that this was sustainable? So far this year, I’ve personally talked to 30 people that were left holding the bag, and EVERYONE loses. How could this not be seen?
2. Disposable Income for all. Before the implosion, Option One got smart and put a disposable income requirement on all of their sub prime paper. Other lenders should do the same thing. A simple debt ratio test isn’t much of a measure. Figure out what the cost of eating and commuting are, and make sure the debt ratio supports that and then some. Fannie and Freddie have not had any formal disposable income requirement, and putting a per person guideline there makes more sensible underwriting.
3. Lower Debt Ratios for First Time Home Buyers. Many people foreclosing are FHTBs, where it seems that everyone involved with the transaction is pushing them into more house. Put a line there so they know what other expenses exist when buying the house.
4. Pay MORE attention to payment shock- Even if someone is starting a new, salaried position, let’s make damn sure that we’re watching the ball and that payment shock is a serious black mark. I don’t know how many “move up” buyers I’ve seen spend all of their increased salary on housing. Ratios work, but the lifestyle change is pretty dramatic–and one couple I’m working with has two houses to maintain because their “done” deal died at the last possible minute.
5. Don’t treat guidelines as entitlements: Originators often “massage” a file to get it to where it had 45% back end ratios. This makes it the “slam dunk…” Broker/banker actions weren’t necessarily fraud, it would be doing things like calculating income or debts in the way most advantageous to the borrower. Have a common sense bias, be willing to reject loans.

There are other ways to fix underwriting guidelines to stop the bleeding. What are yours?

Chris Johnson is a mortgage originator in Westerville, OH with a front row seat to a declining market

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