The who, what, when and why of mortgage loan denial

The figures are in, and they’re disturbing: The Federal Financial Institutions Examination Council reports that 2 million people were turned down for mortgages in 2010; and lending restrictions are only getting stricter.

Reducing Risks Takes Top Priority

The logic of loan application denial hardly qualifies as rocket science. Reducing risks makes sense to banks now, and indeed, higher standards seem to be reducing the number of defaults, meaning fewer foreclosures in the future. According to RealtorMag, “Fewer than 1.3% of loans originated in 2009 that were resold to Freddie Mac and Fannie Mae went into default after 18 months, government data show. That’s down from more than 22% default rates for 2007 loans and about 3% default rates in 2002.”

Quicken Loans says that avoiding defaults is primary now, because banks who approve loans that go bad open themselves to lawsuits: investors that buy these bad loans could discover mistakes and sue the originating lender. And in fact, multiple lawsuits of this nature have been filed in the U.S. to date. “Our line of defense,” says one Quicken Loans spokesperson, “is to cross T’s 42 times and dot I’s 52 times. With home prices continuing to fall across much of the nation, lenders realize that any mistake could be fatal.”

The Fallout

Not surprisingly, many would-be homebuyers who fail to qualify after months of jumping over myriad lender hurdles give up. The Mortgage Bankers Association estimates the market loses 3 in 10 buyers, either because they are denied a mortgage and don’t try again, or because they drop out during the application process. Considering that real estate accounts for 10% of this country’s economic output, this percentage should disturb us all.

What Are the New Requirements?

Some of the biggest reasons for rejection are:

  • buyers coming with insufficient income
  •  bad credit
  • applicants with FICO scores below 620 are usually rejected, although some lenders are rejecting anyone below 660). Through June, single-family home loans bought by government-backed Freddie Mac had an average credit rating of 751, up from an average of 707 in for loans originated in 2007
  •  low appraisals
  • lenders usually want a two-year history of income
  • lenders want 20% (or more) down.

Who Gets Rejected?

Many Americans don’t seem like “good risks” to banks anymore. Groups most vulnerable under the stricter regulations include:

  • freelancers/independent contractors
  • single parents or just single buyers
  • people who have changed jobs recently
  • people whose jobs include large amounts of cash remuneration (think servers, bartenders)
  • people with shaky credit: that’s a lot more people these days
  • people whose past investments are considered too risky or over-extended
  • people who’ve recently made big purchases like a car or similar that puts them in “too much” debt

Sadly, in terms of who these people actually are, think: millennial who, unable to find “traditional 9-5” jobs, work at start ups or contract out their labor to several organizations. Think: retired folk, baby boomers who have a lot of rental properties, stocks, or other investments that could (in the banks eyes) go wrong. Think: returned military members who may have good savings but do not have immediate job prospects, or who are injured and not considered “good risks.”

Aside from these applicants, even applicants who seem to have everything a bank could ask for get rejected these days. But our focus in the next few weeks will be on the specific groups we who have the most trouble qualifying for a loan today, but who also represent the changing face of the American homebuyer.

Readers: Are these stricter guidelines fair, or overboard? Are banks protecting the country or making the situation worse?