If you’re thinking about buying a house and you haven’t applied for a mortgage since 2006, you’re in for an unpleasant surprise. The lax standards of the real estate boom era—like “no doc” loans, approved without supporting documentation, and “stated income” mortgages, where no proof of income was required—are history. If you want a mortgage today, get your credit score up, pay off debt, put some cash in the bank, and get your paperwork in order because you’re going to be asked to prove your income, assets, debts, and other financial commitments.
Today’s tighter standards have resulted in a greater percentage of loan denials and higher FICO scores. In 2010, for example, the nation’s 10 largest mortgage lenders denied 26.8 percent of loan applications, an increase from 23.5 percent in 2009, according to an analysis by The Wall Street Journal.
The leading reason a lender will deny your loan is because it has concerns that you can repay the loan. You’ll need to prove your ability to pay the loan before you receive any money from the bank by doing the following:
- Prove you have steady employment or a reliable income stream. A new job or self-employment raises red flags.
- Pay down your debt and don’t accrue new debt. A high debt–to-income ratio is a warning sign to lenders.
- Show you have enough cash saved up for the down payment, closing costs, and cash reserves in case of an emergency.
- Allow your lender to verify the source of the funds for your down payment.
- Make sure your credit reports show no recent late payments or “charge-offs” to creditors who have not been paid according to the terms of their financing agreements.
- Check your credit score; having a higher credit score is crucial.
Average FICO credit scores for loans approved by Freddie Mac and Fannie Mae today run in the 760s compared to 620 to 640 during the housing boom. Ellie Mae, a company whose software processes 20 percent of all U.S. mortgages, reports the average FICO score among denied applications has risen to 750 from 741 since August 2011. Even the FHA is requiring a minimum FICO score of 580 to qualify for a loan with a 3.5 percent down payment.
Some, notably the National Association of Realtors and the National Association of Home Builders, claim that these tough new hurdles are impeding the housing recovery by making it extremely difficult for qualified borrowers to get mortgages. A white paper issued by the Federal Reserve in January agreed, noting that mortgage lending has significantly declined among potential first-time homebuyers—an important source of incremental housing demand.
In February, Federal Reserve Chairman Ben Bernanke called for increased lending to creditworthy homebuyers and more loan modifications and mortgage refinancing to help revitalize the housing industry and economy. The NAR reported Bernanke said in a speech to home builders that tightened borrowing was necessary to protect banks, investors and borrowers during the housing crisis, but now the pendulum may have swung too far.
Is this pressure sending a signal to lenders that their tight lending policies may be doing more harm than good? As the spring home-buying season gets underway in earnest, can homebuyers look forward to more moderate lending practices and underwriting policies? Unfortunately, the answer so far seems to be no.
Steve Cook is editor of Real Estate Economy Watch and covers real estate and mortgage finance for leading news sites. He is a member of the board of the National Association of Real Estate Editors and was twice named one of the 100 most influential people in real estate. Cook was vice president for public affairs for the National Association of Realtors.