Mortgages: What Are The Self-Employed To Do Now?

With the increased delinquency and foreclosure rates, there is a resulting tightening of underwriting standards across the entire mortgage industry. Prior to the mortgage meltdown we are seeing today, the pendulum had swung way to far to the lenient side of credit score and income documentation requirements; so much so that nearly anyone that could simply “fog up a mirror” could qualify for a mortgage loan with little or no down payment.

Now the pendulum has swung way to far to the opposite end and this tightening has caused many programs to literally vanish overnight. Unfortunately, many of these creative programs were abused by the greed of the industry and by dishonest borrowers (yes, unlike the press or the politicians, I said the borrowers are just at fault as the industry….) speculating on the market. The abuse of these “creative” products is a lot of the cause of what we are seeing today.

This is as much the result of the over-reaction from all the press and political hype coming out of the current state of the mortgage industry as it is the result of the true statistical facts from those programs. It makes great sensational news and is quite “politically-correct” (and beneficial) to blast and blame the big-bad mortgage companies and banks and not blame the borrowers that were just as guilty of taking advantage of the low-document loan programs.

One group of borrowers that are suffering from the tightening of underwriting standards is the self-employed. Prior to the current restrictive guidelines, a self-employed borrower with good credit and good cash-flow, but tax returns that didn’t sufficiently document (prove) take-home income to qualify for a conventional loan, could get a loan with what was called a stated-income documentation or no-document loans. Simply, they didn’t have to document or “prove” their income, but could state it on an application and the lender would use what you said as your income to qualify you. In exchange for this lesser-documentation requirement, you had to agree to pay a higher rate, assume some risk of adjustable rates, and your credit scores greatly affected the resulting rate.

Now those programs have all but disappeared for those with little or no down-payment. There are still low document, stated income and no-doc loans, but the tightening of underwriting guidelines force the self-employed borrower to have either a greater down or higher credit scores (or both) to qualify. Of course, they could choose to qualify for the conventional full-documentation loan using the income analysis of their tax returns, but typically, this would cause them to qualify for the lower-priced house.

When it is determined that some sub-prime borrowers are unable or unwilling to manage their credit and therefore are best to simply rent homes rather than purchase… until such time that they make it priority enough to be homeowners and manage their needs and wants enough to limit their use of credit except to buy a home.

So where will it go from here? Read on...

The pendulum will end-up swinging back to somewhere in the middle over the next couple of years. In the favor of some sensible meeting-in-the-middle is the fact that housing is the key to the entire economy AND there will still be a large appetite for mortgage backed securities and competition for that securities product will cause investors to loosen things up a bit to attract investment.

When all is analyzed over the next few months and years and it is determined that all parties were at fault  (not just the lending community) and that speculation and greed was a big part of the problem; some of the creative product will return. As loose as we saw this past few years… not likely, but many of the features and benefits of these lower-documentation loans will be available again.

Side Note for consideration: If the industry simply underwrote mortgage loans based purely on credit scores, the rate of default and foreclosure would change minimally of any at all. I know that is not very “politically correct” but statistics prove over and over again that 8 out of 10 sub-prime (low credit score) borrowers that don’t manage their credit or debt today, won’t in the future and that 8 out of 10 borrowers that do manage their credit and debt today, will continue to do so in the future as well. The other 20 percent in both categories, have either a one-time tragedy affect their lives, and thus their credit, or do change their ways and learn to manage their money and debt better; their scores improve and thus they become eligible for conventional mortgages.

After twenty-six years in this industry, I believe the underwriting of employment and of assets is flawed. The very day after a mortgage loan closes, a borrower’s financial picture can and most likely does change. They could spend a significant amount of their saved assets or even spend every dollar that was verified before closing, and what they were qualified with is no longer valid. They could and often change employment and even entire careers right after closing so all the verification that was done prior to closing is now longer of any value or significance. They immediately go into further debt as a result of the needs and wants in their newly-purchased home, the purchase of a new car they were waiting until after closing to buy.

If a lender had the guts and financial ability to hold the paper (since the secondary market - Wall Street - would not purchase these loans… yet) this credit-score-only qualifying could be tested. What I believe is that the majority of borrowers will not buy more home than they can actually afford and that if their credit is important to them, they will do whatever it takes to make their house payments. The borrower could simply state their income, like they do in consumer and credit card applications and the rate would be set by credit and down payment.

Adjustments to rates could be considered, such as first time homebuyers versus proven homeowners (maybe first-time homebuyers would have to have some sort of mortgage insurance) and owner-occupied versus investment property. Then set rates in tiers tied to credit scores (720 score and above is a base rate; then scores from 700-719 would be 1/8th percent greater, 680-699 another 1/8th greater, 660-679 another ¼ greater again and then 3/8’s to ½ percent greater for every 20 credit-score points under that.

Then down payment would be the other determining factor in setting the rate. 20% or more down is at the base rate determined by the credit scores and would not require mortgage insurance. And then for every 5% less down, the rate would be adjusted up 1/8th percent over and above the credit score analysis above and a fixed percentage is added for mortgage insurance.

In this simplified underwriting, the employed or self-employed, salaried or commissioned income borrower are treated on a more equal bases. It virtually eliminated any possibility for discrimination as well. Here are the borrower’s credit scores (which for the most part are an accurate measure of one’s ability to manage debt and their money) and here is their down-payment. Period! The rate is set and it is color and race blind entirely.

The underwriting and processing time would be less than one week in ninety percent of all loan applications. The cost of processing and closing would be cut by 50% or more. The regulation and disclosure requirements would be cut in half as well. The entire approval could be automated, again making it a blind decision every time. And… Hey, it is “Green” too… over 80% of the paper wasted in the mortgage process would be eliminated!

Will any institution ever have the guts to revolutionize the lending industry in this way? It would take one of the big boys to ever attempt it. Bank of America, Chase, Countrywide, Wells Fargo, Washington Mutual and/or very large securities firms would have to work together to make change. Unfortunately I don’t believe so. Too many either working in the industry or that profit by the industry, would be fighting to keep things at status quo and thus protect their jobs. It is nice to dream though!

Comments

[Ron Cahalan]

With your lower loan-to-value, there will still be Interest only ARM's and Stated income products as well. You are correct, in that the scales have been swung too far to the opposing side due to the very small % of borrowers that got themselves in trouble (with the help in the mortgage community) but those scales will come back to some position in the middle. It will be the minimum down and no-down stated income loans that we will probably never see again. Good Luck!