You might recall from part one of these columns that I feel not only do the powers that be have the wrong culprits when it comes to the sub-prime crisis, or credit crunch, they also will not come up with the proper solution. In other words they'll never learn!
Let me outline the specifics I wish to go over and perhaps you will see what I am talking about. The underwriting of loans is right at the top of the list. If they could get out of the notion that every borrower has to fit in a specific box then the tremendous amount of effort that is being made to move each borrower to fit the system would stop and most likely defaulting loans as well. Basically those who fit easily, easily get loans; those who don't, don't.
I have three examples to help you understand.
1. A borrower with a net worth in excess of $10 million with a 750 credit score and total debt of less than $500,000.
2. A borrower with a net worth in excess of $1 million with a credit score of 790 and total debt of less than $500,000.
3. A borrower with a net worth in excess of $7.5 million with a credit score of 640 and total debt of less than $500,000.
The first borrower was seeking a rate and term refinance for $417,000 and was declined. The second borrower was seeking a rate and term refinance for $325,000 and was declined. The third borrower was seeking a $850,000 purchase for a second home with a purchase price of $2,450,000 and was declined. You say that is impossible? Let me tell you more.
Borrower 1 is a widow who derives income from 8 condos, across from a college, that are rented full time and have been for years. The borrower has a multi million dollar other home without a mortgage. There aren't any mortgages on any of the condos. The borrower also owns several businesses that provide income, but the income is written off for tax purposes. The assets in the other businesses are in excess of $1 million dollars.
Borrower 2 is working in same line of work for his entire adult life and is also taking income from his pension. The income he earns from his profession goes into a corporation and is written off for tax purposes.
Borrower 3 is working and has a personal corporation. The income from the corporation is W-2 income to the borrower. The last three years the W-2s averaged $2.5 million per year with the latest year well in excess of that number.
So you ask why were they declined? Borrower number 1's income from the rentals goes into a trust and the income doesn't flow directly to the tax return. As with borrower number 2 the rest of the income is written off for tax purposes and therefore cannot qualify under the ratios that lenders want to see. Borrower number 3 couldn't get a jumbo loan because of the need to have a 660 credit score and of course it is 640. Reason, a late payment of the cable T.V. bill. That is what happened the first time around and I was more than disgusted.
They are now all approved with new loans. What happened? Using the Fannie Mae's automated underwriting we were able to get verbal VOE's (verification of employment) for the first two and we lowered the loan amount to conforming limits for borrower number 3 where a 640 credit score is allowed. Our underwriters understand the automated underwriting parameters and made them fit. Simple as that. But why do we really have to do that? Why can't the lenders, the investors and the GSE's allow an overall look at the borrowers and use some new tools to approve loans. First and in my opinion, and yes this is still my opinion, reserves in the form of liquid assets or guranteed income from pensions and the government should carry a huge amount of weight. Earnings should not be in this league.
Reserves mean that you can weather any storm; earnings show what you made in the past.
In my mind there isn't any contest. If someone gets into trouble you need reserves, plain and simple. Yet recently I had a borrower turned down twice because the ratios of debt to earnings were about 10% to high. You be the judge. The borrower had a house worth $2.5 million in this market, a loan to be refinance of $1.5 mil, which is a 60% loan to value. The family income was made with investments in the stock market and they had $1.6 million in the market. Their credit scores were in the mid 700 range. If they can get in trouble, from any reason, sickness, accident, poor judgment they can either pay off the entire loan, or at least keep the payments going for a very long time.
Now lets go back to the original three borrowers. Borrower number one had assets, primarily real estate, that was over 20 times the amount of the loan. The most important fact was besides the one real estate loan the entire debt was less than $20,000. There were also personal retirement plans and annuities equalling over $1 million. Why did this loan have to be so difficult? Why did the borrower have to fit a box? And by the way the real estate loan was there because it was put on to help a son get the house originally.
The second borrower has more than sufficient income and if they were W-2 borrowers there wouldn't be a problem. The loan of approximately $326,000 was on a house that appraised for $680,000 in this market. It had previously appraised in the $800,000 range and probably will be back there in the near future. What good is it to have a 790 credit score and a refiance only to lower the payments if they have to jump through hoops?
The third borrower was a joke. The income ratios were 1 over 1. This means that 1% of the income is being used for the house payment and 1% of the income is used for the total debt payment. The actual ratios were lower but the program doesn't go any lower. With these ratios, and huge reserves why couldn't a jumbo loan be approved? Score is too low based on a current late. There were even a few older 30 day lates. People forget, people travel and mail gets lost. Wouldn't common sense underwriting work here. It certainly would with my money.
No one wants to go back to the old days when each and every loan had to be analyzed by an underwriter, any more than I beleive we should be handwritting every application. I do think that "fitting the box" can't be the answer to the mortgage revival. I believe that limited underwriting or alternative documentation should have a place today. It can work as successfully as what we are doing and we can start to approve bigger and better loans than we have today.
One of the biggest and best loans I ever did was with a sub-prime company: therefore it could be called a sub-prime loan. It wasn't, but in today's environment it would be lumped in. The loan was for $3.2 million with $1.8 million cash out. The house appraised for $7.5 million 4 years ago when the loan was made and is probably worth more today. (Everything hasn't gone down). The borrower qualified with a W-2 from his primary corporation, a 1099 from a company of which he was a partner and a lease on one of his plants that he held with his corporation as the tenant. He had liquid assets of just under $3 million. The entire transaction took under 30 days including getting the appraisal and the 3 day right of recession. His credit was in the 700 range and still is. The loan is going into the 5th year of a 5 year arm and the payment history is excellent. Everyone benefitted from the loan, borrower, broker and lender.
We need more of this type of lending, not less. It will take some courages lenders and investors, but when it does happen, we will be speeding down the road to recovery and into the 21st century's vibrant financial markets.