Loan Documentation: Tighter Lending Practices Affect the Borrower
We’ve all been a witness to what those in the media are referring to as the “sub-prime meltdown.” However, it is often difficult to separate out the ways in which the happenings in the world of big business and high finance affect us – the average person. And, the media hype inherent in the 24-hour news cycle doesn't really make it any easier. Yes, lending practices have gotten a bit tighter, but that doesn't mean that you can’t get a mortgage if you have credit challenges, such as no credit or bad credit. In fact, today’s tighter lending practices stand to be as beneficial, over the long-term, to those with less than perfect credit as they are to the lender.
A Brief Explanation of What Happened and Why
In simple terms, loose lending practices and low interest rates contributed to a shift in the housing market. Whereas in the past, for many people, the primary motivation for taking on a mortgage for a house was to secure a residential property to live in, in the past couple of decades, many took on mortgages with the intent of flipping the house – selling it and making a profit. This contributed to a fast rise in house prices in many regions, with higher prices requiring higher mortgages.
In addition, through market action, the price or market value of many of the homes being purchased during this period were, in a sense, artificially high. As the market begins to settle back to more normal levels, many have homes with a market value that is less than their mortgage, a serious problem if the house was bought to flip, rather than to live in.
Looser lending practices allowed low document and no document loans to flourish, even in the sub-prime pool. However, these types of loans often were expensive credit, in terms of fees, conditions and rates. ARMs, adjustable rate mortgages became common. Furthermore, looser lending practices, particularly with the low document or no document types of loans, made it all too easy for individuals to end up with more house than they could really afford, as the checks and balances that had been customary were no longer present. Instead of a lender refusing a loan for a certain amount due to a perceived inability to keep up with a repayment schedule, the onus fell more to the borrower to borrow responsibly.
While this shift towards personal responsibility and acknowledgement of individuality in circumstances was a good thing for many, allowing them to successfully obtain – and keep -- homes that they may not have been able to in the past, for those working in the old paradigm, in which a lender would refuse a loan unless convinced absolutely of the borrower’s repayment ability by fairly strict formulae and documentation, this shift carried with it a potential for trouble.
And, with the rise in interest rates that those with ARMs are experiencing and the struggle to stick to repayment schedules that those who got involved with more house than they can afford, as well as a few other factors, including housing market values and prices settling back to more realistic numbers, trouble has arrived. The rate of default has risen, leaving lenders, and the investors that bought such things as mortgage backed securities, stuck for liquidity, or in simple terms, cash. Lenders have had to declare bankruptcy and some have had to go out of business. The result – tighter lending practices are coming back into vogue.
Tighter Lending Means Stricter Documentation Requirements
While tighter lending practices do, in general, mean stricter documentation requirements will have to be met, this is beneficial not just for the lender, but also is good for the borrower. Taking the steps needed to assemble the necessary documentation is a great way to have it clear in your mind what you can afford when it comes to a mortgage. The smart borrower doesn't borrow more, even if eligible, than he really needs. Choosing a less expensive home to live in while saving the amount necessary to get more favorable mortgage terms and conditions for your dream home is usually the better financial move.
While three years ago, it was fairly easy to get stated-income, no ratio, and no doc loans, as well as 100% financing and other non-traditional types of mortgages, times have changed. Some of the biggest names in the lending business have recently made significant changes to the ways they are handling lending.
Washington Mutual, for example, is no longer accepting low document applications if the desired loan is greater than 65 percent of the value of the house if the credit score of the borrower is less than 680. Countrywide recently announced some changes, as well. In the sub-prime lending category, Countrywide is no longer going to feature the 2/28 program, a hybrid ARM type of loan. They are reducing the number of 100 percent financing loans that they make and will be increasing restrictions for those buying their first house. They are also going to start to limit their interest only loans to those with higher credit scores.
The bottom line, then, for those seeking a mortgage to buy a home and for those looking to refinance, is to be prepared to provide documentation of income, assets, debt and all other relevant financial information. you'll need precise proof of income, such as W-2 statements, bank statements, and on paper formal documentation of all other income, like alimony or child support, that is to be included in the total income amount. Debt to income ratio information is also required, so you'll need to prepare documentation of that, as well.
While it may take a little longer to find the right lender if you have no credit or very bad credit, it is not impossible. Use that extra time to work towards saving up for a bigger down payment and to improve your credit status. don't allow yourself to be pushed into getting involved in a loan that may not be in your best interest or is more than you can comfortably afford by desperation or the fear that an opportunity may be your only or last chance. Patience is not only a virtue; it is often the more affordable and wiser option.