Douglas Katz – 2 June 2021
So, I read an article last week trumpeting the loosening of lending guidelines for mortgage loan applications. I actually re-read it several times because, as one in the lending trenches, I am seeing a very different landscape. Deals that I could have done blindfolded with my hands behind my back and my legs shacked together are getting tough and sometimes impossible. In a market where hungry buyers and opportunistic refinancers are still applying in droves, this trend could throw some water on the flames.
Why Are Lending Guidelines Changing?
I should preface detail on where the changes are happening with some backstory as to why they are changing. Lending is about risk. Pricing and loan decisions are based on the institution’s assessment of whether they will be paid back. I have discussions with applicants when they need to provide documentation, why their loan may not be approved or why it priced out a certain way. The best way to think about risk is to look at it on a small scale. If you were lending $1,000 to someone, what would be your considerations? Multiply that by 50, 100 or more and you can see why institutions manage the risk in the money that they lend.
What Does This Mean For Your Mortgage Application?
The lending industry, however, cannot just stop making loans. They are, after all, in the business of making loans, so they generally do so in every macro-economic situation. The process and the specifics of approving loans, however, ebbs and flows with the strength or weakness of the economy. We have been in a trend of loosening standards for a long time. However, as home prices have skyrocketed stressing buyers’ finances and as the post-COVID economy begins to develop, institutions have started to bring more scrutiny to finances in the mortgage application and their deals. As you would expect, this means tougher standards and a more difficult loan decision process for many borrowers.
For a Mortgage Loan Application, You Should Consider…
So, what can you expect and what should you do. For example, if you are already in the process with a pre-approval, what can you expect? If you are considering applying for a mortgage loan, what should you do?
What you earn is how you are paying back the loan. It needs to be steady and verifiable. This is a pretty simple exercise with base salary where a W-2 and some paystubs clearly show what you make. Yet, when you veer into the self-employed borrowers or those who depend heavily on variable pay such as bonus or overtime, things get tougher. Currently for my self-employed borrowers, I am required to provide at least on years personal and business tax returns as well as a year-to-date profit and loss statement with bank statements that support the revenue. If income is decreasing, then you will likely need to explain why and prove that any decrease is an anomaly.
Your ability to repay the loan is not just dependent upon how much you make, but what other debts need to be paid. This is captured in what is called your debt-to-income ratio. Most loan programs have a set allowable ratio for loan approval. This ratio can and does change with the economy much like a pendulum. In the last few years, the pendulum had swung toward more liberal allowable ratios. Now, we are seeing much more stringent enforcement of a 43% debt-to-income ratio, so if the ratio of your income to all of your debts, including the proposed debt for a new loan, is in excess of 43% on conventional loans, you may run into some issues.
This criterion is the ratio of what you are borrowing and the value or purchase price of the property. It is basically the flip side of down payment and the perceived risk of a loan increases as the down payment decreases. While we are not seeing limitations specifically for low down payment, we are seeing low down payment become a significant contributor to the risk assessment of a loan. By this I mean, a lower credit score may not in and of itself impact a loan decision, but a lower credit score with a low down payment could.
Lenders like assets. The more financial resources that you have, the less a home purchase will impact your financial picture. Additionally, assets equal reserves and an ability to whether financial storms that impact income. I am seeing more and more deals where the addition of more assets to an application can help mitigate the overall risk of a borrower and assist in getting a favorable mortgage loan decision.
Choose an Experienced Mortgage Lender to Assist in the Mortgage Application Process
The thing to remember is that this is nothing new and that like many aspects of our lives, it is cyclical. As I said earlier, the pendulum swings back and forth between loan approval guidelines being more and less restrictive. The key is understanding this and integrating where the pendulum is into your decision to apply. Often times, borrowers only think about rate and cost and assume that the process of evaluating their creditworthiness is a constant. This can be disappointing in some cases, but disastrous in others when a pre-approval may have been issued before the tightening of guidelines and the loan is no longer viable.
If you’re in a must act situation like a divorce, it is imperative to stay in tune with these trends as it could mean the difference between keeping your home or needing to sell. As always, choosing a reputable, knowledgeable, and experienced mortgage lender to assist. The internet is great, but it cannot replace expertise. Search our directory to find a SplitReady Pro that can help you navigate the divorce process.