Loan Qualification Requirements and Ethical Lending Standards

Loan Qualification Requirements and Ethical Lending Standards

Cherise DeLucia
James Dallas Smith
Matthew Ringel

The overall health of the economy is gauged by many factors; growth, unemployment, interest rates, the economic environment of individual business sectors and many other components can all impact the economic constitution. The current economic crisis was a perfect storm of interdependency within business sectors that eventually lent itself to a worldwide economic down turn.

The sub-prime mortgage crisis was the result of a blend of low interest rates, inflated homes prices, excess foreign capital, deregulation of lending markets, and ultimately, poor lending decisions made my banks leading to poor borrowing decisions made by consumers. With the use of sub-prime lending vehicles -like adjustable rate mortgages, zero down lending, and stated income loans- banks lent money to people that could not afford the given terms, and consumers were often sucked into loans they did not understand or took on more debt then they could actually afford. We will review the impact of sub-prime lending on the current economic climate and lending markets and examine loan qualification requirements, ethical lending standards, consumer education, and the impact of these cornerstones on the economy as a whole.
When the real estate market was booming it was too easy to obtain a mortgage; on the other hand, when it is down in the slums -as it has been for most of the country through these recent tough economic times- you may have to jump through hoops before seeing any satisfying results. One of the biggest reasons for driving the real estate market down was the extremely loose lending standards and requirements practiced by many mortgage lenders over the past decade. No longer is that the case since the tightened pre-approval lending requirements and unstable economy have put a lot of people looking to purchase a home in a bad position.
In an article written by Lisa Scherzer on SmartMoney.com, she goes through what she calls her, “7 Tips for Getting a Pre-approved Mortgage.” At the top of the list she explains the importance of obtaining a letter of pre-approval, which is simply a letter from a mortgage lender stating they have verified that the would-be borrower is approved for a mortgage for a certain amount over a given period of time. Most real estate agents, and sellers for that matter, won’t even deal with potential buyers unless they have been pre-approved. It’s pretty simple, the letter shows exactly how much the buyer can borrow and lets them know right off the bat what houses in what price ranges they should look for. When it comes to the seller, the letter proves that the potential buyer can indeed afford their home should they decide to purchase and therefore the seller and the seller’s agent can put forth more effort in attempting to close a deal.
One of the next “tips” that Lisa Scherzer has to offer is for the buyer to prepare their financial biography. This step would obviously come before the pre-approval letter since it includes the documentation a lender would need to see in order to pre-approve, but nonetheless a very important step. What this biography allows the lender to do is review and confirm the borrowers income, credit and assets to ensure that they will be able to make the necessary monthly payments in order to fulfill the mortgage requirements. It is most important in times like these to have the proper paperwork put together to allow your potential lender to conduct a thorough pre-approval analysis. Although your lender should let you know what paperwork is necessary, Ms. Scherzer included 5 absolute musts to include: W2 statements, federal tax returns for the past 2 years, bank statements for the past few months, recent pay stubs and proof of any other income, and finally proof of investment income (Scherzer, 2009).

Historical lending parameters usually include a solid credit history benchmarked with a quality FICO score. A FICO score, or “Fair Issac Corporation” score, is a mathematical composite to determine credit risk. It takes into account a consumer’s payment history, current level of indebtedness, types of credit used, length of credit history, and new credit and then assigns a numerical rating to reflect their credit worthiness. FICO scores can range between 300 and 850, with a higher score resulting a more favorable lending status.

Buyers have traditionally been required to come up with a down payment of 20% of the value of the home to qualify for a mortgage. FHA loans can offer smaller down payment requirements, but it was not until the advent of the sub-prime loan that borrowers could attain a loan with little to no down payment. With the popularization of the sub-prime mortgage, consumers were encouraged to take part in the American dream at a risk that ended up detrimental to the economy as a whole.
Converse to the construct of traditional lending standards, sub prime mortgages are essentially loans given to individuals with poor credit and little or no down payments; in which many instances the individual with the loan only pays towards the interest for several years. This was the main reason for companies lending the money in the first place because they are securing most of their profit on the front side of the loan. Due to the struggling economy pre-2001 after September 11, 2001 the Federal Reserve cut interest rates, which in turn expanded the economy and encouraged borrowing. Soon after this, the economy and property values began to skyrocket with no end in sight. Because of this companies and Wall Street were eager to purchase and or sell packaged loans even if they contained less perfect, higher risk, subprime loans.
In 2002, mortgage rates were at a 40-year low, which yielded a very cheap source of equity enticing borrowers (Barnes). More and more people were purchasing homes whether they had the money or not throughout 2006 and into 2007. These subprime mortgages were very appealing because of the low or no down payment required, low interest rates, and a temporary low payment. At the time, another appeal was if the payment did rise an individual could pull equity out of their home to pay it down because of the drastic increase in value that was expected. Ethics play an important part in this situation because lenders were giving money to individuals who could not afford to pay it back. Today there is a concise opinion that millions of people did not know what they were getting into; the blame lies not only with the home buyer but also with irresponsible lenders. This situation lead to the current status on many people losing their homes and or filing bankruptcy because they were too upside-down to ever pay back their mortgages.
On a larger scale these sub prime mortgages yielded a worldwide economic slowdown. All of these loans were bundled up with A+ ratings and sold to investors around the world so when the bottom fell out it affected everyone. The banks/lenders sold these loans in order to free up their capital so they could lend even more money to people via sub-prime adjustable rate mortgages, and with home rates doubling who could blame them. As long as home values kept increasing these sub-prime mortgages would not have a negative affect on anyone’s liquidity. When interest rates began to rise and home purchasing began to slow, individuals with adjustable rate mortgages began to see their monthly payment dramatically increase which lead to defaulting on mortgages. This turn of events also presented problems for the companies who purchased bundled loans, as they were not able to collect on their A+ investments. These subprime loans became toxic to the portfolios they were in although they could not be identified because they had been bundled and re-sold so many times. The subprime mortgage seemed to have collected the whole world economy and millions of people rode it all the way up only to come crashing down.


As the economy continues to recover and the lending markets continue to tighten, more emphasis will be placed on ethical lending standards and conservative mortgage qualifications guidelines. A balance between profits of mortgage brokers and banks is necessary for a stable financial market place and for the financial health of consumers. It is also the responsibility of the buyer, to understand what they can afford, versus what a mortgage broker may offer them. The mortgage crisis created a demand for ethical, quality lending standards and guidelines, as it proved to the entire economy is tied to the success of the lending industry and with that comes responsibility of stability.

Reference:

Barnes, R. (n.d.). The Fuel That Fed The Subprime Meltdown. Retrieved November 18, 2009, from Investopedia.

Collins, J. (2009, October 3). O.C. property investor seeks bankruptcy rescue: Mammoth Equities' defaults are just the latest development in mounting commercial real woes. The Orange County Register.

MSNBC.com. Fed says banks tightening mortgage standards: Both traditional and non-traditional loans are harder to qualify for. http://www.msnbc.msn.com/id/30563498/

Scherzer, L. SmartMoney.com. 7 Tips for Getting a Preapproved Mortgage: http://www.smartmoney.com/personal-finance/real-estate/7-tips-for-getting-a-preapproved-mortgage/

London, A. (2009, August 8). Fed offers mortgage search tips. News Journal,B.2. Retrieved October 1, 2009, from ProQuest Newsstand. (Document ID: 1825954401).

Fha.mortgageloanplace.com/FHA-Loan-Qualification.html

www.searchlightcrusade.net/2009/04/loan_qualification_standards_l_3.html