Loan standards tighten

Spotty credit records are out, bigger down payments are in.

Americans are quickly finding out that the turmoil in global credit markets is making it difficult – and in some cases impossible – to buy a home or refinance a mortgage.

Since the beginning of the month, lenders have tightened their standards. They are now very reluctant to make high-risk loans to individuals with spotty credit records. They're also requiring higher down payments, meaning that home buyers need to have much more money saved up. In addition, some Americans – including the self-employed, consultants who work from home, and those with unconventional sources of income – may be denied home loans.

These changes are not just affecting low-income Americans: Many lenders have completely stopped making "jumbo" mortgage loans – anything more than $417,000.

"It's a different ballgame," says Doug Duncan, chief economist for the Mortgage Bankers Association in Washington.

Behind the change is a rapid shift in mentality by investors, many of whom were burned by bankrupt mortgage lenders and rising foreclosure rates. Their angst has rippled through to the securitization market – which packages mortgages into large portfolios that are bought and sold by investors. This provides liquidity for the lenders. Starting a week ago, however, the buyers of these portfolios stopped buying as they questioned the safety of their investments. "It just disappeared," says Mr. Duncan. "There is no question we have a serious liquidity problem in the market today."

The liquidity issue has prompted both the European Central Bank and the Federal Reserve to inject some $300 billion so far into the markets. But the action has yet to help the securitization market. "We are working feverishly to try to find solutions," says Duncan.

In the meantime, banks are tightening standards. On Monday, the Federal Reserve reported that the majority of the 49 banks it periodically surveys had tightened standards on subprime mortgages – loans made to individuals with less than stellar credit. Nearly half the banks also said they had toughened standards for nontraditional mortgages – for individuals who don't have complete documentation of their income or who want interest-only mortgages. Ten percent of the banks even said they had made lending more difficult for people with good credit standing.

To qualify for nonjumbo mortgages, the minimum credit score has jumped from 620 to 680 (out of a top score of 900), says mortgage broker Bob Moulton, president of Americana Mortgage Group in Manhasset, N.Y. "I am seeing a lot of pullback on products and fewer lenders," he adds.

Banks have tightened credit standards, Duncan says, because they want to protect their capital and their earnings. "If they put a security [mortgage] on their books and it trades at a lower value, they have to ... take a hit on their earnings," he explains.

The Federal Reserve has estimated that the total losses in the housing market during this downturn could come to $100 billion out of a total debt of $10 trillion, Duncan says. The worst hit states, he says, are California, Arizona, Nevada, New York, New Jersey, Maryland, and Florida.

"In other states, foreclosure rates have fallen," he notes. "It's the bigger states on the coast with the higher populations."

In the case of California, the majority of loans are jumbos. In addition, many borrowers signed up for adjustable-rate mortgages (ARMs) that included the option of interest-only payments or some minimum payment. Now, with home prices falling and interest rates being reset higher, delinquency rates and foreclosures are rising quickly in the state.

"California will be the big story for some time," says Duncan. "Housing prices will have to adjust."

Despite the looming losses, banks in the US are still making loans, Duncan is quick to add. But the volumes are down substantially. In fact, most of the loans now being made are mortgages that qualify for resale to Freddie Mac or Fannie Mae – quasi-government institutions that buy mortgages from banks to help provide liquidity. These are capped at $417,000.

Interest rates for 30-year fixed-rate mortgages have remained just more than 6 percent. However, for jumbo loans, interest rates have gone up as much as 1-1/2 percentage points, depending on the issuer. According to Bankrate.com, the national rate is now 6.96 percent, up from 6.7 percent last week for 30-year fixed-rate jumbo mortgages. Some lenders are even offering the larger loans at 8 percent.

But it's no longer just the interest rate that matters, say mortgage brokers. In Scottsdale, Ariz., Steve Walsh, president of Scout Mortgage, describes how he has lost 100 loans in the past few months because "viable candidates" could not get the appraised value for their loans. "Say they bought the house for $450,000, but it's appraised for $400,000," he explains. "Every sale seems to be about 20 percent below the market last year."

The falling prices, combined with higher mortgages rates, are turning some buyers into walkers. Mr. Walsh says he has two customers who found it made more sense to walk away from their $100,000 deposits on $1.5 million homes after the homes dropped $300,000 in appraised value. "I walked away from a $25,000 deposit on a $3 million house in North Scottsdale for the same reason," Walsh says.

The same is true in Florida, says Jack McCabe, CEO of McCabe Research & Consulting in Deerfield Beach, Fla. "Last year, over 50 percent of the mortgages made were volatile adjustable-rate mortgages," he says. "They were heavily used by speculators, and all income levels, and now with prices declining in Florida, we're seeing a large number of walkaway rates."

For example, in Fort Myers, the foreclosure rate is up 400 percent over a year ago, Mr. McCabe says. "We're really in a crisis right now," he says.