The 5 C's of Credit

Jun 27
Category | General

Borrowers know that once they apply for a loan (practically any loan), the lender will underwrite the loan. The underwriting time it takes to review the loan, looking at the borrower’s income, credit report, appraisal of the property, and so on, varies by type of loan and lender. But borrowers should know that approval is never a sure thing, even if they have millions in the bank, or a flawless 850 FICO credit score.

We mention this because the Federal Financial Institutions Examination Council (FFIEC) released Home Mortgage Disclosure Act (HMDA) data. The report shows loan approvals AND declinations: hundreds of thousands of loans needed to purchase homes were rejected. Yes, some of these borrowers went to another lender, but it is a useful exercise for potential borrowers to know why previous borrowers were turned down. And yes, the 5 C’s of credit matter: character, capacity, conditions, capital, and collateral.

The broad categories for turn downs include credit history, affordability and income, assets and down payment, and property issues. The list of reason start with the top five: loan amount too big, income too low, inability to document income, using rental income to qualify, and the DTI ratio being exceeded.

Moving down the list, the FFIEC’s HMDA data shows mortgage rates rise and push payments too high, payment shock, LTV (loan to value) too high, inability to obtain secondary financing, and underwater on mortgage. (Remember that there are programs for such individuals.) Next is not enough assets, unable to verify assets, no job or job history too limited, changed jobs recently, self-employment issues, using business funds to qualify, limited credit history, credit score too low or the spouse’s credit score too low, and so on.

It is not difficult to see that the reasons all return to the 5 C’s of credit, and these need to be kept in mind when applying for a loan, and for dealing with underwriting conditions.

How Long Does it Take to do a Loan?

Jun 23
Category | General

One of the most common questions a loan officer is asked is, “How long will my loan take to do?” Of course, when hardly any documentation was required, loans took much less time. But now, with increased underwriting, documentation, and so forth, it is taking longer. And in some instances, much longer. Refinance applications and appraisal complications are holding up home sale closings, according to a recent survey. According to the report, the normal timeline for a closing is about 30 days. However, the survey found the timeline to be between 45 and 60 days.

Adding to the average time is the length of time required for short sales and sales of foreclosed homes. These have always taken longer to close, but since this component made up over 44% of the nationwide market in September they have really added to the timelines. The survey of 2,500 real estate agents found that one major source of delays among short sales is mortgage origination preapprovals, which sometimes expire before all interested parties agree.

Sales of foreclosed homes are encountering delays when property damage complicates the appraisal process. In many parts of the nation Realtors are saying, “Much more than half, and in some cases three-quarters, of all distressed property closings have been delayed because of loan conditions.” And in some states, like California, laws are further aggravating the problem by forbidding forced deficiency notes on short sales. Under the new law, “seconds are not willing to settle,” stated one California agent, adding, “Mortgage application timelines run out for the buyers waiting to receive acceptance, counter or declination.”

Experienced loan officers tell clients, however, that well documented loans can sail through the system – they see it every day. They are in the ideal position to tell borrowers what is required, and how long it should take to fund your loan.

“Should I keep renting, or should I buy?” This is a recurring question of anyone with a landlord. The answer to that question is most assuredly, you should buy. That being said, increasing numbers of renters these days are not taking action. Some believe that we will see another real estate bubble, or another recession. But it could also be likely that renters simply don’t realize that they can afford to buy. Here are some reasons why buying can be both attainable and affordable, and why now may be a smart time to consider homeownership.

Unlike renting, buying a residence is an investment. Every time you pay your mortgage, you are increasing the equity in your home and your own financial wealth, versus paying rent, which is only increasing your landlord’s financial wealth. Moreover, rent payments in many US markets are increasing each year, but the payment on a 30-year, fixed-rate mortgage doesn’t increase.

It’s good to remember that a seemingly small increase in the value of a home can translate into a high percentage return on a borrower’s investment. For example, a borrower purchasing a $100,000 home and putting 20% down or investing $20,000 would actually enjoy a 22% return on their investment if the home grew just 4.4%.

Incomes are ahead of home prices and low interest rates are keeping ownership affordable. The national family median income is $64,751; to purchase a home at the median price with 20% down would require an income of $40,266, or $45,299 with 10% down.

Lastly, mortgages consume a smaller share of household income than they did in the past. Today’s owners devote 15.3% of their incomes to a mortgage, which is well below the 22.1% their mortgages consumed between 1985 and 1999. Meanwhile, according to Zillow, renters put roughly 29.5% of their income to rent, compared to 24.9% before the bubble.

As you can see, the numbers make a solid case: owning could very well be the better option and is achievable for qualified borrowers. One of the main things keeping renters from being owners is that they haven’t done the research or reached out to learn more about how they may be able to finance a home.

Sometimes loan officers are asked the simple questions, “Why should I buy a house? Is it a good investment?” Here in the United States the enthusiasm for buying a home remains remarkably strong. Recent surveys found that almost two-thirds of Americans think that buying a home is the best long-term investment a person can make.

But is buying a house really a good investment? There are plenty of non-monetary benefits to owning a home, but is buying a home a good financial call? As always, it depends on your individual situation, but generally the data suggest that compared to the stock market, buying a home has produced similar or better returns with less risk—especially over longer horizons.

If you compare the increases in the prices of homes and stocks by looking at the S&P 500, stocks seem much more attractive. Since 1975, the S&P 500 has increased more than twentyfold while over the same period, the Zillow Home Value Index, which tracks the value of the median house in the United States, has only increased in price fivefold. Once dividends and rents are included, however, and after accounting for taxes over the period from 1975 to present, the annual return of the S&P 500 is about 10% versus housing’s nearly 12%!

As a homeowner you don’t just benefit from the increase in the price of your home, you also could receive rent, or living in it “for free” after the loan is paid off. There are tax benefits in the form of deductions, versus actually paying taxes on stock dividends or bond income.

And the difference between 10% and 12% might sound small, but over a long period of time it can compound to quite a big difference. Over 40 years an annual return of 11.6% means that a dollar would grow to almost $80 but at 10.4% that same dollar would grow to just over $52. A difference of only 1.2% each year compounds into a difference of more than 50 percent over 40 years.

Any loan officer knows that rates and price aren’t everything - service and experience count for a lot. But despite the low rate environment, many homeowners are not seeking out a refinance to take advantage of the low rate environment. Why not?

Reasons for the unenthused attitude towards refinancing may be due to that fact that people are unaware of their current rate or don’t have the drive to refinance. A recent Bankrate survey found that only 65 percent of homeowners said they are very confident they know their rate, while 35 percent are only somewhat confident, not confident or don’t know their rate at all. In 2014, the rate on a 30-year fixed mortgage was about 4.25% and has dropped more this year, around 3.875%. This is in stark contrast from the 6% and higher interest rate environment seen in 2008. And the MBA is predicting that rates will rise to about 5% by the end of the year as well. 

According to a publication by the National Bureau of Economic Research, (NBER) there’s always a fraction of the U.S. population that never takes advantage of a refinance, even it makes financial sense. According to NBER’s working paper “Failure to Refinance”, “In December 2010, approximately 20 percent of households that appeared unconstrained to refinance and were in a position in which refinancing would have been beneficial had failed to do so.” 

For example, refinancing a $200,000, 30-year fixed rate mortgage from 6.5 percent to 4.5 percent will save more than $80,000 on interest payments over the life of the loan. If this type of homeowner took advantage of long-term mortgage rates of 3.35 percent, they would save $130,000 from a refinance. This type of refinance could equate to hundreds of dollars in savings each month, by switching a $200,000 from a rate of 6 percent to 3.8 percent could mean saving $267 per month.

And with many markets continuing to appreciate, and borrowers having more equity in their homes, it makes all the sense in the world for them to ask an originator about their situation.

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