credit score, buying a home, mortgageA major cause of the housing crash in 2006 and 2007 was poorly documented mortgages that should not have been approved. Many of these mortgages ended in default and contributed to the four million foreclosures that cost families their homes and lowered home values by 50 percent or more in some communities.

Mortgage lenders that made bad loans paid dearly with massive losses that drove some, like Countrywide and Washington Mutual, out of business. The survivors changed their lending practices dramatically, raising standards on credit worthiness and ability to repay and requiring better documentation.

The result is that many homeowners who could qualify for a mortgage to buy or refinance a home in 2005 could not today. Many say that the higher standards have gone too far. For example, from 2001 to 2004, approximately 40 percent of residential loans went to homebuyers with credit scores above 740. Currently that number is in the 50 percent range. Economists at the National Association of Realtors estimate that an additional 500,000 to 700,000 home sales could be made if credit conditions return to normal.

However, many policy makers and lenders disagree. Most view the tougher standards as necessary to reduce risk for lenders and ensure that financing is available for mortgages. There’s no doubt that the tougher standards have helped to stem the flood of foreclosures. Defaults on mortgages have declined about 20 percent a year over the past two years, and foreclosures are expected to return to pre-crash levels in two or three years. Federal regulators are making permanent some of the increase standards, including those addressing the ability to repay and the requirements for down payments, in two rules now being finalized. These are known as the QM (qualified mortgage) rule and the QRM (qualified residential mortgage) rule.

If you are thinking of applying for a purchase mortgage to buy a home, or if you are a homeowner seeking to refinance, here are the key standards that you will have to meet.

  • Down payments. Last year, the median down payment for all homebuyers was 9 percent, but it was only 4 percent for first-time buyers, most of whom used FHA financing. The QRM rule will encourage lenders to make loans to borrowers who put more down (perhaps 10 percent or more, though a final figure has yet to be determined). Borrowers who put down less will pay higher mortgage interest.
  • FICO score. The median FICO score for all mortgages closed in July was 737, according to Ellie Mae, a mortgage-servicing platform that processes more than two million mortgages a year.
  • Loan to value ratio (LTV). The LTV is a metric that helps your lender determine whether the value of the home you are buying is high enough to cover most of the cost of the loan it is making in the event you should default. The median LTV in July was 81 percent, which means the loan is equal to 81 percent of the appraised value of the home.
  • Debt to income ratio (DTI). The DTI is a key metric used to determine a borrower’s ability to repay. All documented income sources are used to compute income. Debt is expressed two ways: all outstanding debt, including consumer debt and alimony, and all debt plus the debt to be incurred by the mortgage for which the buyer is applying. The median DTI in July was 24 percent for all debt except the prospective mortgage. With the mortgage added in, the median was 36 percent.

Mortgage approval rates on the rise

Over the past year, mortgage approval rates have risen nearly 20 percent despite the fact that there is still virtually no evidence that lenders are relaxing underwriting standards. In July, lenders approved 55.4 percent of all mortgage applications, including purchase mortgages and refinancings. That’s up from 45.8 percent in July 2012.

Homebuyers are doing markedly better getting approved than they were when Ellie Mae began releasing its data on mortgage originations. Some 61.4 percent of homebuyers were approved for a mortgage in July 2013 compared to 55.2 percent in November 2011. Better preparation, credit repair, and documentation probably account for the improvement.

 

Steve Cook is Executive Vice President of Reecon Advisors and covers government and industry news for the Reecon Advisory Report.

During his 30 year career in public relations and journalism, Cook has been a print and broadcast news correspondent, served two Members of Congress as press secretary, was a senior executive in the world’s largest independent public relations firm in Washington and Chicago and was vice president of public affairs for the National Association of Realtors from 1999 to 2007.At NAR, Cook supervised external communications including news and editorial coverage, video production, speech writing and communications strategic planning. He helped to manage NAR’s multimillion dollar network advertising program.

Cook is a member of the National Press Club, the Public Relations Society of America and the National Association of Real Estate Editors, where he served as second vice president. Twice he has been named one of the 100 most influential people in real estate. He is a graduate of the University of Chicago, where he was editor of the student newspaper. In addition to serving as managing editor of the Report, Cook provides public relations consulting services to real estate and financial services companies, and trade associations, including some of the leading companies in online residential real estate.