When you get a loan to buy or refinance a home, the approval process can sometimes seem confusing. It might shock you to learn that the bank requirements for a loan is a process that overlays your financial situation. The guidelines, however, are not static. Institutions alter their guidelines to account for their risk tolerance. Simply put, banks and mortgage companies will loosen or tighten their loan requirements as they become comfortable with riskier borrowers for a loan. Often, it is the economic environment and not the individual borrower that causes this shift. In bad economic times, for example, lenders will tighten their lending standards to account for the higher likelihood that borrowers will run into challenges making their payments. This is exactly what is happening now and you need to adjust your expectations to the new lending guidelines.
The COVID-19 quarantine has basically put the world on pause. This cessation of business has also had an extreme impact on economies around the world. Businesses have reduced their hours or completely shut down. Workers in many different segments of the economy have seen their income change drastically. In addition to, they have had to tap into their reserves to make ends meet. Even their 401Ks and IRAs have taken a hit with the drop in the stock indices further weakening their financial profiles. Lenders are moving in conjunction with these external factors and the outlook is a tougher situation for borrowers.
So, what can you expect?
Higher credit score requirements
Lenders look at the credit score as one of the best indicators of a borrower’s future performance. Therefore, they set minimum scores for their loan programs. It is a simple way to match the borrower risk with the program. It is also an easy bank loan requirement to change to adjust with changing market conditions. Chase announced this weekend that they are raising their minimum credit score to 700 on all new conventional loans. I expect this to become an industry-wide trend. So, now might be a good time to pull a free credit report if you are looking at buying or refinancing as that 699 may not be enough.
Higher down payment requirements
In the aforementioned Chase announcement, they also communicated that they are raising their down payment requirement on most programs to 20% and I would expect that most lenders will follow their lead. This is a difficult hurdle for many borrowers, and it is not something that you will see exceptions. Some programs, such as FHA and VA, are designed around low-down payment. So there may still be options, but they will be less prevalent. Chase did also communicate that their programs designed for low-to-moderate income borrowers, sometimes called CRA loans, will also remain unchanged. Because lending to disadvantaged borrowers is a key requirement for most banks, I also expect most other institutions to do the same.
Less options for non-conventional loans
Conventional loans are the ones that Fannie Mae and Freddie Mac will buy and considered to be the least risky for the lender. Jumbo and other loan types are either kept by the lender or bought and sold by entities other than the GSEs (Fannie Mae and Freddie Mac). These options inherently have more risk and stricter bank loan requirements. Many lenders are curtailing offering these loans or, at the very least, are limiting them to their depository or investment clients. Some brokers or independent lenders, i.e. mortgage banks that don’t hold deposits, have been completely shut out of access to some non-conventional programs. This has a waterfall effect to borrowers who do not have less options.
Increased scrutiny on employment and income
Many workers have seen their incomes drop or disappear due to coronavirus. Others have been completely let go. Lenders verify employment and income at application, approval and several days before closing. If a borrower’s situation changes at any point in the process, it will become apparent at these verification points and, if income has decreased the lender will need to re-underwrite the loan with the new income. If it does not pass, it will need to be restructured or, under the worst possible outcome, it will be denied. If employment has changed, even temporarily, as there is no set date for a return to work, the loan will also be re-evaluated and potentially denied.
Bank loan requirements will be stricter, and exceptions will be rare
While bank loan requirements and guidelines are well defined, there are times where lenders can interpret them more liberally when there are compensating factors. In other cases, they may be able to provide exceptions for extremely strong borrowers. Under the current market conditions, lenders do not want to take on the added risk of any deviation from the guidelines. That is not to say this will never happen, but I would expect that it will be exceedingly rare, so do not go into the process expecting that you will get an exception, regardless of your financial strength.
Your relationship with the bank will matter
Banks always look to have the deepest possible relationship with their clients. If you have a mortgage, they also want your checking, savings, et al. It not only makes you more profitable to them, but also reduces their risk a bit. Even under the best markets, this was often a consideration for loan approval, especially for loans that they portfolio or keep on their balance sheet. Now it will likely be essential for any loans that they keep. If you are looking for something “outside the box,” expect the bank to ask you to be more than a mortgage only client.
These times are unprecedented, but the changes from lenders are not. In my 20 years in the mortgage lending industry, I have seen the pendulum periodically swing back and forth. When it swings to a more restrictive environment, like our current situation, it is essential to be more informed and to look at more than just a rate. I emphatically recommend that everyone who currently has a loan in process, even those who only have a pre-approval, reassess all of the assumptions under which they received their approval to see if they are valid. Additionally, this is the time to ask whether you think your lender is the best equipped to get you across the finish line. When in doubt, get help. Your loan depends on it.