Some recent--and huge--changes in home lending.

Some recent—and huge—changes in home lending.

The media makes much these days of the difficulty homebuyers have in getting home loans. Yet markets populated by buyers with money—particularly Silicon Valley's midrange market, ranging in price from about $1M to $3M—teem with well-financed buyers. So what does this inconsistency mean, aside from the fact that a) the media has, as usual, sensationalized the news to sell a few more ads, and b) we're back to the days when the people with money can get more money, and the people with no money can't?

I stay away from writing about mortgages for the same reason I don't give tax advice or tell you how to wire your house. The lending business is far too specialized for an outsider like me (and virtually every other agent I know) to comment on knowledgably. Most agents have a basic understanding of the process, simply because they go through it with their clients time after time. And most can spot flaky mortgage brokers, especially when they disappear the moment you need them most.

But for years I barely knew what kind of loans my buyers were getting. For one thing, I didn't think it was my business. What my buyers decided, with the help of their loan professionals (and many talked to more than one) was up to them. Often my clients used loan professionals I'd done business with and could cheerfully recommend. Other clients used mortgage brokers who, rightly or wrongly, were passed among friends like a hot stock tip and from family member to family member like a treasured heirloom.

Now that financing contingencies are back in style, I need to know the basic terms of my buyers' loans so that I can fill in the blanks in the contract. But I still believe that the type of loan product they use is their own business.

Another reason for not micro-managing my clients' financing is a little-known fact: in my area, the financing terms are the only terms in the purchase contract that can be changed unilaterally by the buyer, as long as the changes don't jeopardize the buyer's ability to close. A buyer can bowl over a seller by claiming in her purchase offer that she'll put down an impressive 50 percent on the house and finance the balance with a thirty-year fixed-rate loan, then change her mind after the seller accepts her offer and put just 10 percent down and finance the rest with a five-year interest-only. So unless the contract has a financing contingency that lets the buyer walk away from the transaction if she can't get exactly the financing terms she wants—and financing contingencies were rare in my area until recently—what little information the buyer puts down under financing terms is essentially meaningless.

The final reason for my reluctance to become an "mortgage expert" is that the mortgage business shifts hourly. Lenders make significant changes in their rates and other terms, entering or leaving market niches, seemingly on a moment's notice. Add to this micro-fluidity the huge macro-changes, the sweeping upheavals in credit markets that either float real estate markets or leave them high and dry, and the only people who can keep up with these changes are, yes, the people in the front lines of the mortgage business, the mortgage brokers and loan agents beavering away in their cubicles absorbing the latest bulletins and rate sheets. It's not a business for part-timers, dilettantes and self-proclaimed experts, but then, no business is, unless the business is bubble blogging.

So I keep the minutiae of the mortgage market at arm's length. However, I recently attended a short workshop on today's lending climate, presented by the two Princeton Capital loan agents in my office. Both are seasoned professionals who do plenty of business and have for years. What follows is based on their handout and remarks.

But first, bear in mind that these Princeton loan agents do business in one of the most expensive micro-markets in the country. Because of this, very little of their brief overview on recent changes in lending focused on the media's topic du jure, subprime lending, simply because a) they rarely do subprime, and b) none of the agents attending the presentation had, or are likely to have, subprime borrowers as clients. The dramatic changes in subprime lending since 2005—first swamping the entry-level market with too much money, then snatching it away—are a matter of little interest to virtually all buyers and their agents in an area where a decent home starts at $1.4M. It is, however, of more than academic interest to entry-level buyers (the few that are still active) and their agents (also dwindling in number) looking and working only fifteen minutes outside the affluent micro-zone in which my office does virtually all its business.

Undoubtedly the most important information I took away is that a borrower's pre-approval letter needs to meet a much higher standard than it did just a few months ago. As with any sweeping generalization, this one isn't always true: in December 2007 I had buyers get into contract with only a pre-qualification, not a pre-approval, letter, while competing with five other buyers in a hot local market. But that miracle was largely due to the rapport I established with the listing agent, and to some astute packaging of the buyers and their offer. And in fact, the reason my buyers made their offer without a proper pre-approval letter is because it takes longer these days to get a pre-approval letter that means anything.

Until recently, a good pre-approval letter said in so many words that the lender had done its due diligence to the extent that only three conditions remained before lender would fund homebuyer's loan. First, lender needed a copy of the purchase contract. Second, it needed an appraisal, to verify that the property was worth what homebuyer had offered. And third, lender needed a title report to verify that seller had the right to transfer title to property, the collateral for the loan, to homebuyer.

Simple, but not really, especially in areas where mortgage brokers were known for slapping together pre-approval letters that looked bulletproof on paper and meant nothing in practice. Sellers and their agents often had to resort to basing their decisions on the name on the letterhead—preferably the name of a broker or lender they'd heard of and had had good experience with—rather than on what the letter said.

That was then. Today, in a tightened credit world, the pre-approval letter needs to go beyond fulsome praise for the borrower and big promises to the seller.

Besides the three outstanding conditions I mentioned—underwriter review of the contract, an appraisal and a title report—the modern, hard-hitting pre-approval letter should mention the following:

the borrower's FICO score; the higher, the better
the amount of the down payment; again, the higher, the better
the actual financing terms: rate, term and points if any
that the lender has verified the borrower's income, employment and assets

A copy of the lender's commitment letter, not just the mortgage broker's pre-approval letter, is extremely helpful. I've also been told that having more than one pre-approval and/or commitment letter isn't a bad idea.

Another huge shift in the mortgage market these days is that financing with less than 20 percent down, so popular during the boom, is getting hard to find. 100 percent financing is virtually extinct. Even the extremely popular 80-10-10 loan (an 80 percent first loan, 10 percent second and 10 percent down payment, thus avoiding mortgage insurance) has almost disappeared. Those lenders still willing to make 80-10-10s will only do so if they hold both the 10 percent second loan and 80 percent first, minimizing their risk in case the borrower defaults.

Something mentioned only briefly during Princeton's presentation, but which may soon become a huge factor in homebuyer financing in California, is that lenders have begun to reduce their allowed loan-to-value (LTV) ratio by 5 percent in markets they've identified as "declining". In other words, if a lender has a loan product that allows an 80 percent LTV (80 percent financing with 20 percent down) then in declining areas the maximum LTV for this loan will be just 75 percent, which means the borrower has to come up with a hefty 25 percent down payment. At the time of the presentation, only severely-hit areas like nearby East Palo Alto had been tagged "declining". Shortly after, however, Wells Fargo named most California counties "severely distressed"—Santa Clara County was just plain "distressed", while San Mateo didn't make the list, even as a "soft market"—and other lenders were expected to follow Wells' lead. (By the way, Wells' list seems arbitrary. Santa Clara County is home to some of the hottest markets in the Bay Area and probably the country, while much of north San Mateo County and most of its east-of-101 neighborhoods have been hammered by foreclosures and the subprime implosion.)

The notorious "liar loans", otherwise known as "stated income loans", have become Exhibit A of the anything-goes underwriting standards prevalent in certain real estate markets during the boom. Like the roach, stated-income financing is a hardy survivor, living through the credit market meltdown but, not surprisingly, now in more elusive form. Today stated-income is available only after the lender verifies the borrower's assets (but not income). And it's much pricier: the interest-rate difference between stated-income and verified-income loans, once as little as .25 percent, is currently about a full percentage point. For example, a verified-income loan offered at 6 3/8 percent jumps to 7 3/4 percent as a stated-income loan. And these days lenders will research the reasonableness of the income an applicant claims by checking typical compensation offers at job-posting Web sites. Lenders are also looking at the stated-income applicant's cash reserves, for two reasons. First, applicant's reserves now must bear a close relationship to his claimed income. Second, lenders are looking for the ability of the applicant to cover two to three months of "PITI" (principle, interest, property taxes and homeowner's insurance).

Also finding themselves in a more difficult lending environment these days are borrowers who own a home (we'll call this home the "relinquished" property) but would like to move up or down to another home (which we'll call the "replacement" property) before selling the relinquished property. These borrowers are typically downsizing seniors or younger buyers moving up to larger homes in better neighborhoods. Most will be stuck with payments on two mortgages until the "relinquished" property is actually relinquished (sold). In the past, lenders would cut the move-up or downsizing borrower considerable slack by crediting him a theoretical rental income from the relinquished property, a rental income based not on a rental agreement in hand but on a rent survey. Now these carefree days are largely over. Not only will move-up or move-down borrowers need to qualify for loan payments on both properties, but lenders are strictly enforcing the standard loan provision that borrowers must move from the relinquished home to the replacement home within sixty days. In fact, we were told that Countrywide is knocking on doors to make sure that borrowers have actually moved in.

As I said, this is only a very brief and simplistic overview of a very complex and extensive sea change in the way homes are financed. And yet, it's not so much a sea change as a reversion to the lending practices in place in 1998 when I first sold homes. Check with a direct lender or mortgage broker for details.

And if you have a pre-approval letter dated prior to 2008, make sure it's still good. It may not be.

Next week: The new "jumbo lights": magic cure or big bust?