Where is real estate headed? Why?
“Dogs and cats living together . . . mass hysteria.”
Lately this line from the movie Ghost Busters has been resonating in my mind—almost daily. Bill Murray’s character may have been speaking of the situational state of New York City during the movie, but in my mind his statement reflects the state of the mortgage business and the effects of the Mortgage Meltdown on the overall real estate market—the present market and the future market.
The government continues to applaud itself for all its efforts to stimulate the housing market and to make it easier for borrowers to refinance their adjustable rate mortgages. While this makes for great headlines in an election year, truth be told, for all of their bloviating they have yet to pass any long-term, let alone meaningful, legislation. In fact, while the Congress puts forth bill after bill that never even makes it to the President’s desk, all the major mortgage banks are changing their guidelines on a weekly and sometimes daily basis.
Most people think that Fannie Mae and Freddie Mac set the guidelines for conventional loans and that HUD sets the guidelines for government loans. While the essence of this statement is true, the reality is that there are many players in the market, each having guidelines that can change both the way a loan is underwritten and the determination of whether the loan can be approved at all.
It all starts with Fannie Mae and Freddie Mac, the corporations backed by the federal government that set the general guidelines for the approval of conventional loans ($417,000 and less). Fannie Mae and Freddie Mac also have the automated underwriting systems that mortgage brokers and mortgage bankers use to determine whether a file is eligible for approval under their guidelines. Now, here is where it gets a little confusing: Just because a prospective home buyer has an automated approval from either a Fannie Mae or a Freddie Mac automated underwriter does not mean he has an approved loan. Hang in here with me . . .
Below Fannie Mae and Freddie Mac on the proverbial food chain are the large mortgage banks—banks like CITI, Chase, Wells Fargo, and Countrywide, to name a few. These banks also have their own filters, or underwriting guidelines. Just because Fannie or Freddie will approve a loan at a certain LTV or DTI doesn’t mean that the mortgage banks will either close or fund the loan. Remember, the money does not come directly from Fannie or Freddie; it comes from the bank.
Okay, now that we have that straight, let’s throw another cog in the wheel and talk about MI—that’s right, mortgage insurance, that horrible cog that no one wants to have. Well, I have news for you: If you are putting less than 20 percent down in today’s lending climate, you will have to have mortgage insurance (MI). MI is insurance for you AND the lender in case the loan goes into foreclosure and the bank cannot sell the collateral for the full amount owed. For example, if you put down 5 percent, the bank will require that you have 35 percent coverage in mortgage insurance, which means that the bank’s exposure is only 65 percent. You may be asking, “What does this have to do with the approval process?” Mortgage insurance companies also have their own underwriting guidelines, so, even if you have Fannie Mae approval and approval from the mortgage bank, you also must have mortgage insurance approval because without it your loan may be denied.
On May 31, 2008, Fannie Mae rolled out its new underwriting engine, which is much harder on borrowers. As I reviewed Fannie Mae’s press releases about this new system, I found some interesting points, including this ominous quote: “Reduced Approve and/or EA recommendation rates.” We have already seen reduced rates of loan approvals. Will this new system be even more restrictive? Investors will be limited to a maximum of four properties financed at any one time, down from ten financed properties. The required minimum credit score has been raised to 580, regardless of the amount of the down payment. So, if you have a credit score of 579 and want to buy a house with 80 percent down, you are out of luck. Fannie and Freddie have also put out tiered pricing models. If you have a credit score of 719 or lower, you will no longer qualify for the best interest rates. Moreover, 100 percent financing has been eliminated.
Confused yet? Dogs and cats living together? Mass hysteria?
You may be asking any or all of these questions: What does it all mean? What does it mean to the real estate market as a whole? What does it mean if I am buying a primary residence? What does it mean for real estate investors? Should I be worried?
Real estate is based on the common law of supply and demand: When demand is high, prices will rise and supply will increase to meet the new demand. Right now we are moving into a strange market: Here in Central Texas the demand for housing is still high; unfortunately, though, there are fewer borrowers who now qualify for a home loan.
We’ll have to wait to see how these changes will affect the real estate market as a whole. In the meantime, it means that more people will be renting, and those rents on homes and apartments will continue to rise. We’ll also see an increased number of homes for sale and a decreased demand for those homes as long as the stricter guidelines are in force.
Although now is a great time to buy a home as an investment or as a primary residence, more and more people are being driven out of the buyer pool and into the rental pool by the stricter guidelines. Therefore, if you are either an investor looking to buy or a homebuyer wondering whether your timing is right, this may be the time . . . if you are qualified for the loan. -John McClellan