The hypocrisy of tightened lending standards and the increased presence of PMI

[Jon P.]

With lending standards just now beginning to loosen from a historic tightening, I find it bizarre (and frankly, offensive) the idea that Private Mortgage Insurance will now be something that will be permanently affixed to all FHA backed loans...even long after the property has the 20-25% equity that has formerly resulted in PMI's vanishing.

It's as simple as this: If the bank is going to hold potential homeowners to high standards, that is fine by me but stand by your underwriting process. For the record, I find the underwriting process to be absurdly stingy, but that's a different story for a different time.

It is hypocritical to make someone run through a gauntlet to qualify for the loan and then slap them in the face with the idea that these borrowers still can't be trusted with the loans fulfillment.  In theory, PMI shouldn't be necessary if the underwriters gamble on the right applicants.

Of course things happen.  Great borrowers can lose their jobs and default.  Obviously underwriters are not soothsayers, but the banks putting money into the market place in the form of a mortgage is an investment on their behalf.  Investments fail some times.  Sometimes you lose...and you lose big.

It is a choice to apply for an FHA loan so certainly there is a "if-you-dont-like-it,-go-home" argument to be made against me. But the fact of the matter is that more often than not, the FHA is what will allow the first time home buyers into the market. If your goal, as the bank, is to protect your investment with such vigor that you negatively effect the market from you reap so much benefit...well, then...bravo.

But if FHA is going to compound their lack of faith in borrowers on top of these high lending standards, I'd appreciate it if mortgage brokers out there would stop pretending like we're all in this together

[Patrick Britton]

@Jon P. I totally agree with you. As a mortgage broker I find the vast majority of the new guidelines illogical, unnecessary and a hindrance to the fulfillment of the American dream.

That being said, consider where we came from. Stated income, no document loans, 580 credit scores, no income or employment or asset verification, etc. were collectively the primary factor behind the great recession - which ruined the lives of tens of millions of people, including my own.

I should say though that FHA loans are nowhere near as popular as they used to be, most likely thanks to their excessive insurance premiums. But what you mean by mortgage brokers pretending like "we're all in this together?"

Quite frankly and don't take this the wrong way, it sounds like you had a pretty bad experience recently with some sort of mortgage broker and aren't too pleased with him/her.

[Patrick Britton]

By the way, we very often put underwriters on some sort of pedestal, probably because of the authority they impose. But trust me when I say that the vast majority are nothing more than glorified clerks incapable of basic reasoning and logic, and are very often proved wrong by more experienced, smarter or more proactive mortgage brokers.

[Andy Mirza]

I agree with the OP but what can you do if FHA is your only option to get in (or get back in) the housing market? The pendulum definitely swung too far in reaction to the loose lending standards prior to the crash. Most politicians don't really know enough about economics, the market, or housing and are still trying to fight the problems from 2002-2006. In doing so, they're making things worse in 2015. Hopefully, underwriting will loosen up to a reasonable level and lenders will lend more and more, especially to first time homebuyers. Hopefully, politicians and bureaucrats will realize they've gone too far and will loosen policies on the government end as well. Nobody wants to see a repeat of the housing crisis. Yes, the taxpayers bailed out the banks but the banks show no gratitude. I've got a glass half-full attitude. Things will get better!

[David Krulac]

You're trying to apply logic to an illogical situation.  Rules and regulations are formulated for the real estate industry by people who don't have a clue about this business.

For example:  Dodd Frank & the Safe Act.  It was aimed at predatory lending but scooped up mom and pop trying to sell and finance a property that the mortgage industry wouldn't finance.  Therefore providing a service, that was made illegal or at least more expensive.

The DF reg that the borrowers have to be mortgage qualified is a joke.  If they were mortgage qualified they could get a mortgage from the big 5 banks.  Most seller financing is for people or property that the big 5 don't want to finance.

And as I talked about in Bigger Pockets Podcast #82, capital gains tax should be indexed for inflation, so that it is a true tax on capital gains and not a tax on inflation.

And while we're talking about illogical.  How about the 1099 requirement for $600 of service or product.  When that reg was created the minimum wage was $1 per hour.  Now Walmart is instituting $9 an hr min, and the government wants $10 min per hour.  So when the $600 threshold was established it represented 600 hours of service at $1 per hour, now it represents maybe 60 hours at $10 an hour.  I pay the guy who cuts my lawn more than $600 a year!  The $600 figure should also be adjusted for inflation.

[Andy Mirza]

@David Krulac I completely agree with you on that last point. I think that most, if not all, nominal limits need to be adjusted for inflation to be fair. Will that happen? Not likely and I refer to your first paragraph in which you say that rules and regs are formulated by people who really have no clue.

[Ned Carey]

Originally posted by @David Krulac:

Rules and regulations are formulated for the real estate industry by people who don't have a clue about this business. For example:  Dodd Frank & the Safe Act.  It was aimed at predatory lending but scooped up mom and pop trying to sell and finance a property that the mortgage industry wouldn't finance.  Therefore providing a service, that was made illegal or at least more expensive.

 Well Barney Frank one of the two main sponsors of the Dodd Frank act, couldn't have passed and economics test if you gave him the answers. I wish more people understood that much regulation doesn't just cost more; it is often counter productive AND costs more. 

[Jonathan Key]

@David Krulac Great response and excellent points. I totally agree with you and I have podcast #82 next on my listening list.

But as I (loosely) understand Dodd Frank, if an individual (or REA) privately sells/finances fewer than 3 properties a year they are not considered a "Residential Mortgage Originator" and would not be subject to DF, correct?

Example: I know a local a private contractor that rehabs and flips houses. He pays cash for the houses he wants as projects for his crews to rehab so he can flip. But he also ends up getting work for big money jobs in a wealthier neighboring city (more than he would make on the flip). The houses are partially rehabbed but he can't hold them as such so he sells and finances them to me to finish (I buy and hold these properties for long term high cash flow). As long as we are not doing more than 2 of these a year than technically we are out of the Dodd Frank reach, correct? (I understand any response or opinion does not constitute legal advice)

[Brian Gibbons]

@Bill Gulley 

[David Krulac]

@Jonathan Key 

There are many requirements and last time I checked not all of the regs were written.  The requirement that the borrower has to be "qualified" still applies.  If they were qualified they wouldn't need seller financing.

And the penalty for non compliance is that the buyer can love there for 3 years free and the lender has to refund all their money.  Can you say "new cottage industry."

[Jonathan Key]

@David Krulac Oh my God....that's insanity!! Of course Congress getting involved in something and issuing laws and regulations usually results in insanity, so I should not be so surprised.

[Bryan N.]

I asked my lender about PMI rates. At 15% on a $122K property PMI was over $300. What's the point? They are just trying to take advantage of a situation. I'll gladly put 20% down and not even mess with it.

[Bill Gulley]

Brian, for folks to get the scoop on this, they'll need to buy my book..........oh, wait, I don't have a book. Sorry, but it would take one to get folks on the right track.

I guess people have no idea of how much input goes into forming regulatory law from the industry, regulators, and even public comment before the politicians simply bless what has been formulated and proposed, all the politicians do is ask questions, gather support and vote, their staff only concludes the administrative side. The FAO will do a cost benefit analysis, the IRS is involved as to tax implications and other agencies effected provide input, all before any final rulings.

Banks do not hold FHA loans, they are securitized, sold off, the bank gets their money+ back, and uses those dollars over and over to fund loans at the table. A bank may hold bonds as an investment, but not the loans they created, except for portfolio type loans.

PMI is for conventional loans, FHA has MIP, guidelines stem from securitization requirements for the entire pool. There are different degrees of coverage for mortgages and FHA carries a % of risk over the entire term of any loan. Banks also will carry insurance as to their potential loss of buying back any mortgage that they may have to buy back, most brokers won't be insured in the same manner. Brokers may be bonded to cover these aspects.

Originators, especially the brokerage side deal more with "assistant underwriters" clerical staff working under a managing underwriter, or underwriting supervisors who they may never speak too, thus the impression of underwriters tagging along with the straw man for a brain. Most brokers don't get into regulatory concerns or pipeline management for securitization or block sales, a better understanding of these "backroom" functions can explain a lot at the retail level.

As to the contractor and seller financing:  There are state exemptions allowed for the number of originations, however when a property is newly constructed or rehabbed, those exemptions may not be applicable as there are special provisions for contractors are more strict under Dodd-Frank.

You'll notice too that the mom and pop who are selling their owner occupied home are exempt, it was the mom and pop RE operators who were screwing the public and the reason the DF Act included seller financed transactions. There weren't just a few bad apples, most of the apples were bad and predatory.

I realize this may go against the popular beliefs of those looking for other to blame, demonize someone for their constrained freedoms to do just anything they can dream up, but every game has rules, one reason we played games as kids was to understand that we had rules besides having fun. I just look at it as being in the professional league now and having rules that keep it that way as opposed to the Wild West. :) 

[Ndy Onyido]

@Bill Gulley

Excellent rendition! when will the book be on amazon? :)

Thanks for sharing!

[Bill Gulley]

Originally posted by :Ndy

Excellent rendition! when will the book be on amazon? :)

Thanks for sharing!

That's almost a BP inside joke, I have threatened to write one for about 5 years. Got somewhat serious last year, have several in the mill, compliance is tuff for 50 states and probably why there isn't a good book on notes! Things change too, by the time is is out, something can change. I'm not sure a "book" is the best format, maybe a website that can be updated. ? > :)

[Mark F.]

@Jon P.  @Bryan N. I've been in the mortgage biz for nine years and though I don't have actual stats, my guess is that most people who opt for FHA financing have little cash for a down payment and/or have somewhat sketchy credit. Most people take advantage of an FHA loan probably because they can do the minimum down payment of 3.5% of the purchase price. People who can put down more probably go with a conventional loan, which has lower mortgage insurance premiums (assuming less than 20% is put down).

With just a 3.5% down payment, values don't need to fall much for the loan to be upside down, which represents some risk to the FHA mortgage insurance fund if the borrowers default. Also, borrowers that don't put down a whole lot of money are more likely to walk away from the home if they run into financial problems than somebody who has invested a sizable down payment.

The bottom line is that FHA loans probably carry more risk of loss than other types of financing because the people that use them often have shakier credit and don't bring large down payments to the table. The MIP premiums reflect that risk, so they're higher. FHA has been taking a lot of losses in the mortgage insurance fund over recent years, so they've been gradually bumping the MIP premiums to compensate.

There's no free lunch out there, so to have the privilege of buying a home with a minimal down payment and somewhat shaky credit (FHA guidelines allow for credit scores as low as 580), you're going to pay up with expensive MIP and UFMIP premiums.

[Paul A.]

I was just looking into my FHA loan today, I did 3.5% down on a 3 plex, and was told that my mortgage insurance would go away after 80% LTV ration. However, reading up today, I've realized that the MIP (Mortgage Insurance) is on forever?

So If I saved the money to knock down the loan to 80%, I would still have to pay MIP (Mortgage Insurance) correct? Albeit, a lower amount (like 20 bucks less a month...).

Paul

[Bill Gulley]

You'll still have the MIP rating as set by the original LTV amount, your additional payment simply pays down the principal, they do not reassess the insurance rate as principal is reduced, that has already been figured into the premium and risks, Might save your money if you have a good rate, if not, consider a refi, the premium will be factored into the payoff.

Good luck :)