Under normal circumstances, approving my mortgage application should be a no-brainer: High income, no debt, high credit score. The missus also makes a good income, has an almost-perfect credit score and has been working for the same business for 28 years.
But these are not normal circumstances.
Let me jump to the end: Yes, we got our mortgage. We put 20 percent down, bought a house that appraised for more than the purchase price and got a 3.25 percent rate on a mortgage that resets after seven years. We moved in last month.
But the process was surreal. Indeed, it was such a bizarre experience that I started hunting for explanations from people in the industry about why mortgage lending has gone astray. I spoke to numerous experts, many of whom spoke only on background. This column is about what I learned.
By just about any measure, credit is tighter today than it has been in decades. Although former Federal Reserve Chairman Ben Bernanke’s inability to refinance a mortgage is merely anecdotal, consider instead the gauge CoreLogic developed. It used 1998 as a baseline and considered six quantitative measurements to evaluate how loose or easy mortgage lending is. By those metrics, this is the tightest credit market for mortgage lending in at least 16 years.
The absurdities of my experience are worthy of its own rant, but rather than do that, I wanted to focus on what went wrong. The factors that led to the financial crisis were many, but let’s focus on three areas:
1) Changes in credit standards
2) Automated underwriting
3) Incompetent documentation
In each case, the mortgage-underwriting industry has gone through several changes: In the 1990s, lenders and originators processed most mortgages manually; they had well-defined credit standards; and they gathered documentation for loans in an orderly fashion.
But once the housing boom of the 2000s began, everything got messy. It was a frenzy compounded by three big errors:
1) Credit standards shifted from the borrower’s ability to service the debt to the lender’s ability to sell the loan to a securitizer
2) Automated underwriting was compromised by banking staffers
3) Overwhelming volume led to documentation errors
These issues created huge problems a few years later when the excesses began to unwind. The foreclosure process was corrupted, the rule of law ignored and property rights were trampled.
Which leads us back to that pendulum. Bankers are still shell-shocked. They are suffering from post-traumatic credit-crisis disorder (PTCCD). Rather than return to the more reasonable standards of the 1990s, they have gone to the opposite extreme.
A few examples:
So-called stated-income and no-doc loans enabled just about anyone to get a mortgage in the 2000s. This was regardless of income, debt ratio, credit history or appraised value of the property. In the past, I referred to this as “Loan Origination Fraud.”
The solution is obvious: Go back to verifying income, checking credit scores and requiring a down payment. What lenders do now goes beyond absurd. They don’t need to see every check written during the past 24 months. An explanation isn’t required for every $2,000 deposit into a family checking account. Three years of both personal and professional tax returns seems excessive. Yet that and more is what banks are demanding.
Those in charge of originating mortgages aren’t dumb; rather, most of them work in large organizations where decision-making is scattered and responsibility is often in the hands of risk-averse committees. Once an organization the size of Wells Fargo or JPMorgan begins to implement tighter credit practices, employees get turned into paper-pushing bureaucrats.
Fearful of more oversight, they engage in overkill.
Perhaps what is needed is a good-faith exemption so bankers who have checked off the main boxes – credit score, income, debt ratio, down payment, employment history and loan-to-value ratio – can use a little judgment for a change.
All of this is a sign that banks failed to learn from their mistakes. Instead, they seem to be bent on making new ones. Federal rules put in place after the financial crisis to prevent reckless lending are being used as an excuse to do less lending.
Extremes at either end of underwriting standards lead to bad outcomes. In the 2000s, banks ignored traditional underwriting to make reckless loans that went into foreclosure in record numbers. Since the crisis ended, they have failed to make loans to qualified borrowers through an excess of caution.
The lesson not learned: Smart mortgage underwriting, not extreme looseness or tightness, is the how banks make money in the housing sector. It also has the added benefit of giving a kick to the economic recovery.