Financial Reform: Harder To Buy, Sell, Lend
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(Friday) August 6, 2010
By James Cullum
alexandrianews.org
Councilman Frank Fannon. (Courtesy Photo)
On July 21, President Barack Obama signed the Dodd-Frank Wall Street Reform and Consumer Protection Act into law. While the legislation imposes reform on Wall Street and the banking industry and puts an end to sub-prime lending, it also raises credit standards that could make it more difficult for people to buy homes.
“Now, for all those Americans who are wondering what Wall Street reform means for you, here’s what you can expect,” Obama said at the signing ceremony. “With this law, we’ll crack down on abusive practices in the mortgage industry. We’ll make sure that contracts are simpler – putting an end to many hidden penalties and fees in complex mortgages – so folks know what they’re signing. With this law, students who take out college loans will be provided clear and concise information about their obligations. And with this law, ordinary investors – like seniors and folks saving for retirement – will be able to receive more information about the costs and risks of mutual funds and other investment products, so that they can make better financial decisions as to what will work for them. So, all told, these reforms represent the strongest consumer financial protections in history. And these protections will be enforced by a new consumer watchdog with just one job: looking out for people – not big banks, not lenders, not investment houses – looking out for people as they interact with the financial system.”
For five of the past seven years, Alexandria City Councilman Frank Fannon has been ranked as one of the Top 200 Mortgage Bankers in America by Mortgage Originator Magazine. “There are 2300 pages in the bill. Obviously, a lot of the federal officials don’t know what’s in there and the banking industry is slowly going to unravel what’s in there and it’s going to take a couple of years. And there’s going to be new timetables as to when the new laws go into effect,” he said. “We’re expecting more than 250 new laws and regulations that we will have to abide by in the lending and the banking world. And what’s going to happen is that there’s going to be a huge learning curve through banks and financial institutions. What most companies are doing is setting up in-house people, where part of their job is to figure out what’s in this bill and what kind of changes we need to make.
“Consumers who want to borrow money and financial institutions are going to have a lot more paperwork. There’s going to be a lot more disclosures, regulations that go into every transaction, and it’s going to take more time to complete transactions. When people apply for mortgage loans, we used to have a time when we could get them done in 10 to 15 days. But before, when a loan would get processed, you may need only three people involved. Now there are seven or eight people involved, from taking an application to go all the way to the closing.
“Mortgage banking did the right thing from 1993 to 1999 because you had income-to-debt ratios, you needed to put a minimum of five percent down to buy a house and only qualified people could get home loans. And we got to a position where we were way too liberal giving out the money and now we’ve gotten way too conservative,” Fannon said. “Homes aren’t really selling and moving like they should be because only 42% of the mortgages that are out today are eligible for refinancing with the current guidelines. And the reason for that is that 22% of the loans in the country are upside-down now, which means they owe more than the house is worth.”
What Happened To The Market?
The root of the problem was too much money. “Investors around the world sent money into the U.S. mortgage market because they knew that they’d get a six to seven percent return on their investment,” Fannon said. “The problem was that there was so much money that was available and there weren’t enough qualified borrowers. All these banks and Wall Street firms had all this money to lend and they lowered the credit standards. By doing that, the investors wanted to get the money out, but when they sent it to Wall Street and capital markets, they never said what guidelines they need to lend the money on.
“And then Fannie Mae and Freddie Mac, the government sponsored entities that have held the whole housing market together, they were losing so much market share to all these outside investors that they started doing Stated Income Loans and No Document Loans. And that’s what created this problem – since everybody could get into a property. Then, a lot of these loans started to go bad in 2007 and 2008 and that’s when house prices started to fall,” Fannon said.
Alexandria was not as affected as the rest of the country by the declining economy and housing market.
“Alexandria and Arlington are holding up very well to surrounding regions. Old Town, Rosemont and Del Ray are arguably three of the strongest neighborhoods in the country. We’re so close to Washington, we have metro access. Even though job growth is hurting throughout the country, we’re doing a lot better than other areas. We’re only about five percent unemployment in Alexandria and the State of Virginia is at about seven percent. We’re under the national numbers here,” said Fannon. “Alexandria is very unique. We have 150,000 people now and half of them are renters. The City’s population – approximately 50% of them turn over every five to six years. There is opportunity right now. But you’re not going to find a single family home in Alexandria for $250,000, just like you’re not going to rent a place on Park Avenue for $1400 a month. That’s just the way it is. But there are some condos on the West End of Alexandria that you can buy for under $300,000. There’s opportunities if you want to live in Alexandria City, but if you want to go 21 miles down the road in Woodbridge, you can buy a single family house for $150,000.”
A Changing Industry
Even before Financial Reform, the mortgage industry was shrinking. In June 2005, there were nearly 500,000 loan originators in the country. “Now there’s about 90,000. That just gives you an idea of how much the industry shrunk,” Fannon said. “About 140 banks went out of business last year and 108 so far this year. So, the banks right now, they’re tightening the credit standards. They don’t need the federal government to tell them to do that. For a while there, people started thinking that a house was an ATM machine and was an investment to flip, like a stock. But housing is getting back to where it should have never left. A house needs to be something that you buy, that you live in for five to eight years, because you don’t know where your cycle is going to go. If you go back 200 years in any civilized society, real estate appreciates at about six percent a year. From 1982 to 1989, prices skyrocketed in Alexandria; 1989 to 1992 you had this big drop; then, from 1992 to 2001 you had steady appreciation; from 02’ to 07’ you went off the chart and then it dropped in 07’ and we’ll flatline for a few years.
“Federal Housing Administration loans have always been one or two percent of the market share. But there were so many other loans out there that nobody really paid attention to FHA. Today that’s 37% of the market. One out of every three loans today is an FHA loan. Wells Fargo and Bank of America were the two largest mortgage companies in the United States. They still are, but they had seven percent market share in 2005. They have 50% market share now,” Fannon said. “The last thing a homeowner and the bank wants is a foreclosure. Any lender wants to work out the situation. If you have a real borrower who wants to stay in a house and he has a $3000 payment but he can only afford $2000, all the banks are re-looking and they’ll take the person’s application and most of them are making adjustments on the payments. I mean, it might take four to six months to do it, but it’s being done because nobody wants a foreclosure on their hands. It’s not good for the bank, the consumer, the neighbors. Everybody loses. The way we avoid that in the future is that only qualified folks will be able to buy homes.
“Traditionally, your monthly mortgage payment shouldn’t be more than 30% of your gross monthly income. Your total debts shouldn’t be more than 40% of your gross monthly income to qualify for a loan. If somebody makes $60,000 a year, then that’s $5000 a month in gross income. Thirty percent of that is $1500 and your mortgage payment shouldn’t be more than that. Your total debts, including your mortgage payment shouldn’t be more than 40% of that, which is $2000. So, we did that all through the 90s and then we got away from that,” Fannon said.
The Importance Of Good Credit
Since the housing market meltdown, credit standards have increased. “You have to have very good credit to make these loans work. If a loan program calls for a 680 credit score and yours is 675, you can’t get the loan,” Fannon said. “Right now, Fannie Mae is in receivership by the Federal Government, so at Fannie Mae, they have federal workers in there right now monitoring when they work. So, there’s no exceptions. You used to be able to get an exception on a guideline, but you can’t do that anymore. That’s very frustrating when you’re trying to get a homebuyer into a house and his credit score is one or two points off and you can’t do the loan. This has really affected people being able to buy a house.”
But there is good news. “It’s not like nobody can get a house out there,” Fannon said. “If you have a 620 credit score, which isn’t super high, you can do an FHA loan with a three-and-a-half percent down payment. So, you can go buy a $200,000 house for $7000 and your total payment would be $1500 a month. That’s why FHA has 37% of the market right now, because Fannie Mae and Freddie Mac have really tightened their credit guidelines tremendously. The guidelines are just tighter out there, but if you’re a first-time homebuyer, it’s a great opportunity to get into a property.”
Condominium loans present a problem during a bad economy. “In a good housing market, condo prices are the first to go up, but in a cold market, they are the first to collapse,” Fannon said. “The other challenge is that when someone applies for a loan to buy a condo, there’s two approvals that they have to go through. The bank has to approve the person’s individual credit, but there’s also the credit of the condo association. And that’s where we’re seeing a lot of problems. Condominiums have to have 10% of their annual income in cash reserves and if they don’t, then we won’t make the loan. Even if you have someone who has perfect credit, a great job, it may not matter. When you’re in a condo you’re also in an agreement with your other homeowners. If more than 15% of the condo owners are late on their fees, then Fannie Mae won’t do a loan in there. So, if you have 100 people living in a condo and 17 don’t pay their dues, you have to make sure two people pay their dues up before Fannie Mae will do a loan.”
Fannon has advice for prospective homebuyers. “Make sure to pay all of your credit cards on time and have no late payments,” he said. “The best credit scores I see are from people who have three or four credit accounts open and they pay them all on time. Also, let’s say if you have a $10,000 limit on one of your cards. If you owe less than 50% on that, you will have a better credit score than if you owe more than half of your limit. When credit cards get closer to being maxed out, that negatively impacts your credit score.”