Loose underwriting standards a troubling trend
By Scott Ramella - May 2000
Over the past 5 years, there has come to my attention a very disturbing movement in the back offices and underwriting departments of America's mortgage companies. With the advent and proliferation of automated underwriting, I have seen a gradual move away from the sound underwriting principals of the past 50 years in home loans.
Thirty years ago, there was no such thing as Private Mortgage Insurance (PMI). If you wanted to buy a home, you had to save and come up with a minimum of 20% down, in some cases 10% for government sponsored programs. In the past 3 decades, the federal government has made a concerted push on making home ownership possible for low and middle income families. While this goal is worthwhile because home ownership brings many benefits to the individual and society, I think in the past 10 years the scale has tipped too far in the other direction. The great economy of the 1990's has allowed many banking institutions to ignore sound and time tested underwriting guidelines in favor of more loans and higher profits. If you wish to purchase a home today, 5% down is the common rule. You must carry PMI because 5% does not always protect the lender if home prices in your area fall, the bank cannot find a buyer at market prices, or the property falls into disrepair. The 5% down is supposed to protect the lender from the borrower walking away from the property.
Today, you can either get into a home with 3% down, use a gift as a down payment, or even have nothing down if you have good credit. Obviously, more people can buy a home today than ever before. But at what cost? Bankruptcies remain high even in our favorable economic climate. What is going to happen when the economy cools, let alone a recession? There are literally millions of homeowners in properties that are worth the same amount as the existing loan balance, leaving no equity. I believe the reckless pursuit of profits in the financial sector will spell significant problems further down the road if foreclosures increase in number. The average price for a home in the San Francisco bay area is now over $300,000. What happens if a property's value falls to $200,000 when there is a $280,000 loan balance? In order to sell the home or move, you have to come up with $80,000.
Bankruptcy no longer carries the stigma it once did. You can declare bankruptcy, pay your bills on time for 2 years (not difficult since you dismissed most of your debts) and get the same mortgage as someone who has never made a late payment, with only 5% down and a low rate. To exacerbate the problem, the automated underwriting programs will approve people with debt loads that almost equal their income! I have seen loans approved and closed with an 80% debt to income ratio. For example, this translates to an individual with $3000 a month (gross before taxes) income carrying monthly revolving debts of $2400. Home equity loans and 125% loans only further worsen the situation, as many people treat these as crutches to pay off credit card and unsecured debt.
As long as the U.S. economy continues to outperform, there shouldn't be a problem. As soon as the unemployment rate starts to increase and people can no longer pay the mortgage payment they probably shouldn't have been approved to carry to begin with. There will be a large number or properties on the market and home values will drop, making it even more difficult for people to cover their mortgages in the event of a sale. I don't think this mortgage meltdown will be as severe as the 1980's S&L crisis, but I would not be surprised if the taxpayer is left footing the bill for the lending institutions latest case of greed.
Scott Ramella (SRamella@aol.com) is a licensed mortgage broker for the State of Florida, has a bachelor's degree in Finance, and has been actively involved in the mortgage business since 1995 in several capacities.
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