In spite of the severe credit crunch that followed the mortgage meltdown, underwriting guidelines, while more cumbersome, are still fairly liberal when considering certain aspects of an applicant’s financial situation. I remain perplexed about the lack of common sense that abounds in the underwriting decision-making process.
I’ve mentioned this before in previous columns, and I’ll do so again. My pet peeve is that underwriters are not approving loans to folks who don’t need the money. Old-school bankers used to say the best customer to lend money to is the one who doesn’t need the loan.
Yet I have a client who’s trying to refinance his $300,000 mortgage, secured against his house, which is worth $800,000. He has $1.5 million in retirement funds and an additional $500,000 in cash. His credit scores are perfect. The bank, however, won’t refinance his loan because he recently retired and has no income because he hasn’t set up his distributions from his retirement account. The bank says it needs a two-month history of distributions before it will grant him a loan. The $2 million already in the bank doesn’t count for anything.
On the other side of the coin, I am getting loans that may appear to be dicey approved every day through the automated underwriting systems of mortgage giants Fannie Mae and Freddie Mac.
Loans with debt-to-income ratios of up to 49 percent typically are approved by Fannie and Freddie, even if the application discloses very little savings.
The debt-to-income ratio takes into account the new mortgage payment plus certain other monthly obligations Fannie and Freddie consider long-term debt. These are payments on things such as installment loans, minimum payments on credit cards, student loans and such.
Let’s illustrate. A mortgage applicant makes a salary of $80,000 per year, or $6,667 per month and wants to refinance his home, lower his interest rate and take out cash to make some home improvements. The new loan amount is equal to 80 percent of the property’s value. He has great credit but no significant savings.
His property appraises for $400,000, so he applies for a $320,000 loan. The balance on his current loan is $290,000, allowing him to take out almost $30,000. His credit report indicates he has car loans and credit-card debt that requires payments totaling $1,000 per month.
The mortgage processor calculates his new monthly mortgage payment to be $2,000, including taxes and insurance. She adds the other payments on the credit report and comes up with $3,000 to be the applicant’s total monthly debt. She divides the $3,000 into the monthly gross income of $6,667 and finds that the applicant’s debt-to-income ratio is 45 percent.
She submits the application to Fannie Mae’s automated underwriting system, and it sails through with an approval.
Is this dicey? Let’s take a look. If this fellow is like most salaried folks, he can expect his take-home pay to be about 70 percent of his gross pay, or roughly $4,667 a month. Out of this, he must pay out $3,000 to cover his mortgage, car payments and credit cards. This leaves him with $1,667 to live on.
This $1,667 must cover items such as utilities, home maintenance, insurance premiums, health coverage, clothing, food, telephone, cable, Internet and many other bills, not to mention the high cost of raising a family, if he has one. These expenses aren’t counted in the debt-to-income ratio.
As an experienced loan officer, I urge my clients to be mindful of their particular spending habits when deciding on how big a mortgage they want. Just because a lender is prepared to lend a particular sum of money doesn’t mean the borrower should accept it.
Yes, a 45 percent debt-to-income ratio might be excessive for some folks, but Fannie’s happy to approve the loan. Yet the multimillionaire with no documentable income can’t refinance and lower his interest rate.
Fannie and Freddie, are you listening?
Send e-mail to henrysavage@pmcmortgage.com.
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