Bob and Mary were purchasing their retirement home in a senior community in El Dorado Hills. Both had credit scores above 800, a modest pension and, after their 50 percent down payment, they still had a $1 million in a diversified investment portfolio earning healthy returns. Their loan originator said my client’s loan was a “no brainer” a “slam dunk” and she would have the loan documents into title in 30 days. Two weeks after that deadline we still could not get my buyers a loan approval and the builder was cancelling escrow.
My clients could have written a check for the home rather than going through the painful process of qualifying for a loan but their income they were earning from other investments was more than their mortgage payment would have been and so they had decided to finance half of the purchase price. Although they were collecting social security and a small pension, they needed some of the income from their investment to qualify for a loan. Documenting that these investments over the last few years were generating substantial cash returns was verified by tax returns and statements from their financial advisor. Providing proof that similar earnings would continue wasn’t so easy.
The issue was a mortgage underwriting requirement that says that if the borrower is using any income other than W2 wages to qualify for a loan, it must be documented that the income will continue for another three years. That’s easy enough, I thought. Call their financial advisor and ask for a letter stating that the income would continue.
It was a brief call. “I’m not going to put in writing that these returns are going to continue. New federal regulations prohibit me from even offering an opinion. Besides, what if they cash out and remove their funds?”
A few years ago, this situation would not have been an issue. Banks would have made an exception for a borrower who had a 50 percent down payment and had a million bucks left over. The Dodd Frank bill has made underwriting exceptions on federally insured loans impossible. Stated income loans were another option for non-traditional income borrowers but today regardless of good credit scores and large down payments, those loans are no longer an option for self-employed or borrowers with income from sources other than wages. Not allowing flexibility for large down payment borrowers whose income doesn’t fit into conventional mortgage underwriting is flawed and outdated. The rules need to change or millions of retirees and non-traditional wage earners will continue to be denied loans.
Loan underwriting is the process of reviewing the applicatiant’s file to determine the risk to the lender of default. While much consideration is given to the ratios between the borrowers W2 income and debt service, little consideration is given to the percentage of down payment. A borrower whose down payment is 70 percent of the purchase price is looked at no differently than a borrower who is making a 10 percent down payment. The interest rates for borrowers who are using FHA loans with a 3 percent down payment are less than a borrower who is making a 50 percent down payment on a conventional loan.
The problem with stated income loans in the past was their absence of any down payment. The 80/20 loans allowed borrowers to become homeowners without any of their own investment. The housing crisis wasn’t caused by sub-prime or stated income loans. It was more the result too many borrowers with too little equity. Millions of homes were highly leveraged purchases based upon speculation of ever-increasing prices. Millions more were equity extraction refinances, converting equity into cash to buy stuff or pay down consumer debt. When values plunged, homeowners without equity could not sell, could not refinance and millions lost their home. Equity homeowners had options and were able to ride out the housing recession. They could sell, rent or hold on until the real estate market improved. It is equity and not high credit scores and low debt ratios that prevent foreclosures.
One component that determines the mortgage interest rates is the risk of default. Interest rates are higher for borrowers with a higher risk of default. This was a successful loan pricing strategy for many years. Borrowers with great credit, large down payment and verified income received the best interest rates. Today, with federally owned Fannie and Freddie, the interest rates are basically all the same. Borrowers either qualify or they don’t.
No one is advocating we return to the reckless lending practices of the past. However, most borrowers who eventually went into default had acceptable credit scores, jobs and income. What they didn’t have was equity. Regardless of credit or employment the default rate for borrowers with a 20 percent down payment or more was negligible.
Historical defaults records show little risk when a borrower is making a 20 percent down payment and no risk of default with a 35 percent or greater down payment. Then why do federal regulations prohibit stated income loans and not make allowance for borrowers who don’t meet the traditional W2 employee income?
Millions of boomers are reaching retirement age. Their housing situation will likely change as they downsize. If they can’t pay all cash for another home, they must rely on the availability of mortgage financing. They should not be denied a mortgage simply because they don’t meet the W2 income ratios. How about we give seniors a break?
Ken Calhoon is a real estate broker and can be reached at [email protected].