Today’s guest post comes from Robert Katula, who blogs at Under the Blue Tarp.
The Federal Reserve must be sick and tired of the housing crisis. Chairman Ben Bernanke made it perfectly clear during yesterday’s press conference that housing is THE headwind slowing down the economy. Little does the Federal Reserve know that the Scales of Justice, as a metaphor, is one of the main reasons behind the push back on economic growth.
Let me explain, as I just hit you with a lot in that one sentence.
Mortgage applications are odd enough on the face of it. Your loan officer asks you all those questions not to see if you will qualify, but rather to collect the data necessary to see if your economic and credit profile, housing type (primary, second home, or investment property), and the value of the collateral (the home you own or wish to buy) conform to specific risk criteria. Every loan is either sold to Wall Street or bought or guaranteed by Fannie or Freddie once you sign the closing documents. The analysis of all this information is where things go sideways. Much like when chocolate chip cookies are made, the information is mixed together in computer software and an answer is rendered. Loan decisioning software, created by Fannie and Freddie, spits out one of four results: approved, denied, referred, or referred with caution. It is the computer-approved loans that have a built-in fallacy.
The loans at the heart of the housing meltdown were approved even when all the risk layers did not conform. If an applicant had a higher than allowable debt-to-income ratio, a credit score of 680 and above, very modest liquid assets, and a loan-to-value equal to or better than requirements, the software allowed these positives to offset or compensate for the lack of income.
Got that? I know you are thinking this has to be a joke. To make matters worse, I can count on one hand the number of applications I took where the borrower had enough liquid assets to survive more than a year financially if a life event suddenly clobbered them.
Normal income ratios for Fannie and Freddie are 28/33 percent of an applicant’s gross monthly income. As my last video blog demonstrated, those numbers are dubious enough. But many applications that were computer approved, and validated by loan processors, saw borrowers that used 40, 50, and even 55 percent of their gross monthly income. Holy foreclosure, Batman! Even if there was not a foreclosure, these homeowners were living off of bread crumbs.
The soaring price of home values did contribute mightily to this scenario. But even so, only God knows how many loans were funded with high debt-to-income ratios. This much is known. The low-hanging subprime fruit, those applications with poor credit and high income ratios, have already foreclosed. Now we are into fully documented prime loan homeowners. FHA’s sudden rise of market share is a danger sign. These loans allow up to 43 percent of a borrower’s gross monthly income (nearly 70 percent of net income).
The practice of using compensating risk layers has to stop. Income should be based on at least net income. And most importantly, lenders, Fannie, and Freddie have to start pulling old loan applications to find out how many borrowers had income that exceeded known underwriting standards.
Make no mistake, this is loan triage. We better find out what is going on in every household. Guessing or waiting for loan servicing to report delinquencies is no longer acceptable. The Scales of Justice, in this instance, are not blind.
Robert Katula has more than 25 combined years of experience in Congressional affairs, lobbying, public policy, mortgage banking, and business planning. His blogs can be found at underthebluetarp.blogspot.com and on Facebook at Under the Blue Tarp.
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