The Real Problem in Housing: Mortgage Guidelines

Mortgage rates have declined in recent weeks, but that doesn't mean lenders are working around the clock to qualify borrowers and fund loans.

Writer Henry Louis Mencken once said, "Complex problems have simple, easy to understand, wrong answers." When the federal government took over Fannie Mae and Freddie Mac, mortgage rates dropped, prompting the Feds to congratulate themselves on a job well done. Unfortunately, the lower mortgage rates haven't stabilized the housing problem.

Short history of mortgage lending

Back in the 1990s, it wasn't easy to get a home loan. You usually needed a solid income, a healthy down payment, and good credit. Most mortgages were conservatively structured as 30-year, fixed-rate loans. A report by NERA Economic Consulting entitled Subprime Meltdown: A Primer provides an interesting look at how this conservatism gradually gave way at the outset of the new millennium. In 2001, subprime originations totaled $120 billion. By 2005, subprime originations had risen to $625 billion, or approximately 20 percent of all mortgage loan originations.

Subprime mortgages are higher rate loans made to less creditworthy borrowers. The growth of subprime over time represents the industry's increasing willingness to qualify borrowers under less restrictive mortgage guidelines.

A great many of those subprime mortgages have fallen into default and/or foreclosure. Because this trend affects housing values and the residential real estate market, in general, the problems have now begun to impact prime borrowers, as well. 

This brings us to the crisis at hand. Lenders and mortgage investors have been burned by exuberant mortgage lending practices. After realizing that mistake, lenders retooled their underwriting guidelines with a slant towards extreme conservatism. Some borrowers have complained that mortgage applications are now being denied at even the slightest hint of risk.

Guidelines, not rates

In today's world, it will be the conservative underwriting guidelines that keep you from getting a mortgage, not the rates. Even if rates were 2 percent or 20 percent, you still might not qualify for a loan.

To get a conventional mortgage, you must have a solid income, a healthy down payment, and stellar credit. It may sound radical, but it's just a return to the old way of doing things. If you have lesser qualifications, you might have to pursue an FHA-insured mortgage instead.  This is a good option, but it presents another hurdle: getting the seller to accept your offer. The FHA has more stringent requirements pertaining to appraisals and the condition of the home being sold. A seller who advertises a home "as-is" may not be interested in your FHA financing. Some FHA home seekers have reported a cool reception when the property owner is a bank.

When lawmakers beefed up the FHA, they probably didn't expect that scenario-that sellers of foreclosed homes would steer clear of FHA mortgages. But again, the housing problem is a complex one. And clearly, no one's exactly sure how to fix it.