By Rick Tobin
Every financial “boom and bust” housing cycle over almost the past 100 years has been directly or indirectly tied to the flooding of markets with relatively cheap and easy money prior to the banks and Federal Reserve slamming their doors shut to the access to affordable capital for their customers. The access to third party capital is truly the main reason why housing is positive, stagnant, or negative partly since the vast majority of consumers need some type of third party financing to purchase residential or commercial properties.
In spite of interest rates reaching historical lows in recent years, it is still quite challenging to qualify for a home mortgage. This is especially true since the vast majority (upwards of 97% +) of funded conventional and secondary market residential mortgage loans have been either government backed or insured especially after both Fannie Mae and Freddie Mac were both bailed out by the federal government back in 2008. It is interesting and quite synchronistic that the average FHA loan funded is typically also near 97% loan to value (LTV) financing, and that upwards of 97% all funded conventional residential loans were either government backed or insured (e.g., FHA, VA, USDA, Fannie Mae, Freddie Mac, etc.) in recent years.
The Dodd-Frank Wall Street Reform Act
The Dodd-Frank Wall Street Reform Act was signed by President Barack Obama into federal law on July 21, 2010. Dodd-Frank, in turn, created the Consumer Financial Protection Bureau (CFPB). One of the main alleged core reasons for the creation of the Consumer Financial Protection Bureau was to rapidly improve mortgage loan pricing and fee disclosures for U.S. consumers.
The Consumer Financial Protection Bureau later established the Qualified Mortgage (QM) and the Ability-to-Repay Rule. To best simplify the explanation of Qualified Mortgage and the Ability-to-Repay Rule, lenders were supposed to better qualify their prospective buyers for mortgage loans, or these same lenders (banks and even individual sellers offering certain types of seller financing options) might be financially liable for future loan losses should the borrower later default.
These Qualified Mortgage guidelines made the qualification for mortgages much more challenging for mortgage loan prospects. An example of tighter underwriting guidelines is the maximum ceiling of the 43% debt-to-income (proposed mortgage payment, and possibly other fixed monthly debts, as a percentage of mortgage prospect’s gross monthly income) rule for any conventional loans to be saleable in the secondary markets. Some old subprime and Alt-A lenders used to allow much more flexible underwriting guidelines with upwards of 50% to 60% debt-to-income ratios.
Both Qualified Mortgage and the Ability-to-Repay Rule went into effect on January 10th, 2014. Shortly thereafter, it became much more difficult to qualify for conventional mortgage loans in spite of mortgage rates hitting incredibly low rates in recent years. Cheap loans are exceptional options for property owners IF they can qualify for these same mortgages.
Qualified Mortgage and an Ability or Not to Repay
The key root word in the “Qualified Mortgage” phrase is the shorter version of the first word which is “Qualify.” A mortgage loan product is useless for a borrower who cannot qualify for it, even if the lender is paying their clients 1% per month to borrow money from them, somewhat akin to a NIRP (Negative Interest Rate Policy) bank account option.
Let’s take a look below at the Consumer Financial Protection Bureau’s own words used to describe their Qualified
Mortgage (QM) and Ability-to-Repay guidelines from their main website:
“A Qualified Mortgage is a category of loans that have certain, more stable features that help make it more likely that you’ll be able to afford your loan.
A lender must make a good-faith effort to determine that you have the ability to repay your mortgage before you take it out. This is known as the “ability-to-repay” rule. If a lender loans you a Qualified Mortgage it means the lender met certain requirements and it’s assumed that the lender followed the ability-to-repay rule.
Generally, the requirements for a qualified mortgage include:
- Certain harmful loan features are not permitted, such as:
- An “interest-only” period, when you pay only the interest without paying down the principal, which is the amount of money you borrowed.
“Negative amortization,” which can allow your loan principal to increase over time, even though you’re making payments.- “Balloon payments,” which are larger-than-usual payments at the end of a loan term. The loan term is the length of time over which your loan should be paid back. Note that balloon payments are allowed under certain conditions for loans made by small lenders.
- Loan terms that are longer than 30 years.
- A limit on how much of your income can go towards your debt, including your mortgage and all other monthly debt payments. This is also known as the debt-to-income ratio.
- No excess upfront points and fees. If you get a Qualified Mortgage, there are limits on the amount of certain upfront points and fees your lender can charge. These limits will depend on the size of your loan. Not all charges, like the cost of a credit report, for example, are included in this limit. If the points and fees exceed the threshold, then the loan can’t be a Qualified Mortgage.
- Certain legal protections for lenders. Your lender gets certain legal protections when showing that it made sure you had the ability to repay your loan. Even with these protections, you may still be able to challenge your lender in court if you believe it did not make sure you had the ability to repay your loan.”
(*source above: http://www.consumerfinance.gov/askcfpb/1789/what-qualified-mortgage.html )
Ability to Repay Rule
“The ability-to-repay rule requires most mortgage lenders to make a good-faith effort to determine that you are likely to be able to pay back the loan. This is important because during the financial crisis many lenders made loans without making sure borrowers had enough income to repay their mortgage loans. As a result many borrowers ended up in risky loans they could not afford. Congress responded by passing a common-sense law that says mortgage lenders must make a reasonable effort to figure out if a borrower has the ability to repay the mortgage before the loan is made.
The CFPB is responsible for enforcing this law, and we have written a rule that says lenders have to make a reasonable and good-faith effort to figure out a borrower’s ability to repay a mortgage. In practice this means lenders must generally find out, consider, and document a borrower’s income, assets, employment, credit history and monthly expenses. Lenders cannot just use an introductory or “teaser” rate to figure out if a borrower can repay a loan. For example, if a mortgage has a low interest rate that goes up in later years, the lender has to make a reasonable effort to figure out if the borrower can pay the higher interest rate too.”
(Source above: http://www.consumerfinance.gov/regulations/ability-to-repay-and-qualified-mortgage-standards-under-the-truth-in-lending-act-regulation-z/ )
High FICO Scores and Less Qualified Borrowers
Over the past several years, conventional lenders have been funding mortgage loans for borrowers with much higher average FICO credit scores than perhaps ever seen in the mortgage profession. Lenders want to meet the Qualified Mortgage and Ability-to-Repay Rules while also not potentially being financially “on the hook” for their customers’ future mortgage defaults as well as not losing their access to government-owned secondary market institutions such as Fannie Mae and Freddie Mac. Most banks need to unload their funded loans as quickly as possible in the secondary markets. Should primary banks lose access to secondary markets, then these same banks may eventually run out of cash.
Ellie Mac (https://www.elliemae.com/ ), a technology company which analyzes mortgage data, recently reported that the average FICO (Fair Isaac Company) credit score for funded conventional loans in December 2015 was 754. This average FICO score was just one point lower than the average FICO score for mortgages funded in December 2014. FICO scores range from 300 (very poor credit risk) to 850 (exceptional), so a 754 credit score is almost equivalent to a very solid “A” credit score.
What is even more mind-boggling is that FHA (Federal Housing Administration) mortgage loans funded in December 2015 had an average FICO credit score of 688. It is a bit of a head scratcher because this average score was 7 points higher than the average FICO scores for funded FHA loans the month before in November 2015, and that FHA loans used to be known for much more flexible FICO score approvals in the 500 and low 600 FICO ranges in many cases.
The average FICO score nationally is closer to 695. Yet, only about 47% of younger Millennials (people between the ages of 18 and 35) have FICO scores above 670. Millennials, as of 2015, represent the largest percentage of home buyers nationally as well as the largest generation of all Americans. As a result, the number of qualified first-time home buyers for conventional mortgage loans is declining in many regions of the U.S.
Subprime and Alt-A Loans to the Rescue
As far back as the late 1990s, several subprime mortgage credit lenders were offering 100% loan to value financing for both owner and non-owner occupied residential loans (1 to 4 units). Some lenders offered zero down loans, with or without formal proof of income or assets, to as high as $1 million to $1.4 million dollars. Some lenders would offer these loans to clients with FICO scores as low as 620, and also did not require any proof of income such as tax returns or W2 forms, or even bank or investment account statements in order to confirm proof of liquid funds.
In 2015, a large number of institutional investors such as crowdfunding platforms for real estate and hedge funds significantly reduced their acquisitions of real estate for both residential and commercial properties. As a result, many conventional banks and private funding sources are getting more aggressive with their mortgage underwriting policies by reintroducing subprime and Alt-A type loans products with much easier mortgage loan qualifications such as lower FICO scores, less paperwork documentation, and even 100% financing for properties as high as $2 million in order to provide more non-Qualified Mortgage type financing options for individual investors at much higher loan amounts.
As a prime example of more flexible mortgage financing in 2016: Let’s take a look below at the $2 million dollar “Poppy Loan” offered by a federal credit union in the San Francisco region with no money down and 100% financing as described from the financial institution’s own website below:
“STOP PAYING RIDICULOUS RENT!
For the first time ever, San Francisco Federal Credit Union has created a home loan product that offers up to 100% financing. Created by San Franciscans for San Franciscans who are fed up with paying ridiculous rents. The customizable POPPYLOAN™ is a game-changing solution that can significantly reduce the down payment needed to make your dream of home ownership a reality.
Why did we create POPPYLOANTM ?
We were seeing too many people interested in home loans, who were qualified in every way, and either didn’t have enough money saved up, had to tap into their retirement accounts, or needed to borrow from a family member for the 20% down payment required for a conventional mortgage loan.
We also see Bay Area rents skyrocketing. It’s not that people can’t afford to make a house payment (look at the amount of rent that’s being paid!), it was the lack of funds or access to the size of down payment that is typically required. We wanted to find a solution to this growing problem and help our community.
As San Francisco’s credit union of choice, we delivered a real solution for our community. Our Proud Ownership Purchase Program for You – POPPYLOANTM is our answer to the down payment problem so many people struggle with when trying to buy a home in the Bay Area. Too many people living and working in San Francisco give up the dream of homeownership or moving up to a larger home. The necessary down payment would require they commit their entire nest egg to the home purchase. They see it as hopeless. POPPYLOANTM brings back that hope, brings back the real opportunity to stop paying ridiculous rents and start having your money go to work for you.
How does POPPYLOANTM work?
It’s simple, really.
- POPPYLOANTM is available to anyone who works in San Francisco or San Mateo County.
- The home you want to buy and will live in as your primary residence must be located in one of the 9 Bay Area Counties. These are San Francisco, San Mateo, Marin, Napa, Sonoma, Santa Clara, Alameda, Contra Costa, Solano.
- You can finance up to 100% of the purchase price or appraised value, whichever is less – all in one loan.
- Loans are available up to $2,000,000.
- There is NO added cost of Private Mortgage Insurance (PMI).”
(*Source above: https://www.sanfranciscofcu.com/poppyloan )
History tends to repeat itself partly since so many of the main financial institutions and investors follow the same script over and over. First, these same banks flood the markets with easy money while almost begging consumers to take the money from them. The same investors, in turn, acquire discounted properties and ride the appreciation wave for several years prior to the banks turning off their access to capital. Once the figurative water spigot to cash is turned off, then the markets begin to taper off or decline.
“Rinse, recycle, and repeat” as the markets and investors try to clean themselves up prior to the next financial boom. To me, one of more encouraging signs to be seen today for a potential upturn in housing markets is the potential for more flexible mortgage money access for a much larger number of mortgage prospects. Money makes the world go ‘round, for better or worse; mortgage money continues to be the primary driver of the housing markets.
There can be a very fine line between sane and insane (“fog a mirror and qualify for a loan”) loan options available during any “boom or bust” housing cycle. Hopefully, we will one day find the best middle ground so that we can have more stability for real estate and the rest of the U.S. economy. We do still have the one main positive of near record low mortgage rates helping those people who can qualify for conventional and non-conventional mortgage loans, regardless.
Author: Rick Tobin 
Look for Rick’s ebook on Amazon Kindle: The Credit Crisis Deals: Finding America’s Best Real Estate Bargains. Rick Tobin has a diversified background in both the Real Estate and Securities fields for the past 25+ years. He has held seven (7) different Real Estate and Securities brokerage licenses to date. Rick has an extensive background in the financing of residential and commercial properties around the U.S with debt, equity, and mezzanine money. His funding sources have included banks, life insurance companies, REITs (Real Estate Investment Trusts), Equity Funds, and foreign money sources. You can visit Rick Tobin at RealLoans.com.