In the wake of trouble in the subprime lending market, regulators are cracking down on lenders in an effort to shelter consumers from unnecessary risk. While the rules are meant to protect borrowers, they may wind up making it harder for them to get certain types of mortgages.
Americans will lose up to $164 billion in home-based wealth due to foreclosures in the subprime mortgage market. That was the discovery by the Center for Responsible Lending, a nonprofit research and policy organization, which conducted a study. Twenty percent of all the subprime loans issued during 2005 and 2006 will fail, the research predicts, and government regulators are not taking this news lightly.
Various agencies and lawmakers have called for tougher guidelines. As a result, banks and mortgage companies have begun to implement their own proactive regulations, in an attempt to avoid further government oversight. Borrowers will immediately feel the effect of these changes. Despite being armed with more information than ever before, consumers will find it more difficult to qualify for certain types of home loans.
ARMed and dangerous
The markets most affected are the subprime and adjustable-rate mortgage (ARM). During the past few years, mortgage companies have offered lots of ARMs with exceptionally low “teaser” rates. These introductory rates made it easy for homeowners to borrow larger amounts of money with lower monthly payments, and the loans sold like hotcakes. But when the initial period expired, these loans “reset” to keep up with prevailing interest rates. Because rates have been recently rising in a steady way, homeowners with these ARM loans have seen their monthly payments skyrocket, often doubling within one payment cycle. Many borrowers, however, have been unable to make these inflated payments, and have been forced into foreclosure. The new governmental rules require that lenders do a more transparent job of explaining the inherent risks of these loans to their customers, through more candid disclosures.
Incomes don’t lie
Mortgage companies must also limit prepayment penalties and curtail the use of so-called “stated income” loans that are a part of most subprime mortgages. With a stated income loan, the borrower tells the bank how much he earns, but these claims to income are not officially documented or verified. Because borrowers are prone to exaggeration, they often state much higher income than they actually show on their tax returns. As a result, they wind up buying more house than they can afford, and eventually default. From now on, mortgage lenders will verify any stated income to make sure that it’s accurate.
Show me the credit
Banks are also looking closer at credit scores. Instead of reviewing an applicant’s past year’s payment history, many lenders will now go back a full 24 months. And, if you apply for a mortgage with your spouse, lenders will probably qualify you based on the lowest credit score of each of the partners in the marriage, not that of the spouse with the best credit or an average of both scores.
While the new guidelines might seem like obstacles, they help to ensure that people don’t get into more debt than they can safely and comfortably handle.