Why Are Mortgage Guidelines So Strict?
Let’s first talk about what a lender’s “underwriter” is, since I’ll be using that term throughout this post. An underwriter is an individual at the bank who reviews your loan application and financial information to decide if you qualify for a mortgage.
There was a time when getting a mortgage was based on common sense. The underwriter would look at your credit history, income, how long you’d been at your job, and your ability to save. Based on all of that, they would decide whether or not you were a good fit for a loan.
However, things changed in the 1970s
Wall Street got involved. Banks started grouping similar mortgages together into “baskets” – similar credit scores, similar loan-to-value, similar income – and handed them off to securities firms who sold them to investors. Wall Street made massive profits from this, so they became hungrier for more. Because of this, lenders were pressured to approve more and more loans.
Then came the 1990’s
By the 1990s, it was so easy to get a mortgage that it became a joke in the industry that people were getting approved for loans using their dog’s name! These loose rules led to what became known as “liar loans.”
The economic crash of 2008
Then came the 2008 financial crash. The “liar loans” had allowed anyone to buy a home they couldn’t afford and they now found themselves in foreclosure.
New, strict guidelines were developed as a result. At the same time, computers were becoming more advanced, and software was developed to ensure loan applicants adhered to the new guidelines.
Computer programs are exacting and follow what they are programmed to do. For example, if a loan requires a credit score of 700, a score of 699 will get you rejected or at the least earn you a higher interest rate—even if that lower score was due to something out of your control, such as a late payment on a bill due to illness. Computer programs don’t account for gray areas; they only see black and white.
Today, it’s up to borrowers (and of course, the loan originator) to understand what underwriters need to see and to make sure their financial profile fits the requirements. For most loans, a computer program determines what paperwork is needed. The underwriter’s job is simply to check that everything is in order.
This is a basic explanation of how mortgage applications work nowadays, especially for conventional and FHA loans—the most common type of loan, which usually comes with the lowest interest rates. There are other types of loans, known as “non-qualifying” loans, that have different requirements. They might be easier to get, but they often come with higher interest rates.
In short, mortgage guidelines are strict today in part because of lessons learned from the past, but also because of the “secondary market”, the Wall Street world where numbers mean everything.
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