US banks set mortgage bar too high for self-employed

DESPITE recent moves to backstop the US mortgage market, the freeze on lending has not thawed for many self-employed people.

DESPITE recent moves to backstop the US mortgage market, the freeze on lending has not thawed for many self-employed people.

Washington’s support in the sector has made it easier for many people with decent credit scores to get a loan, but for the self-employed, even financially secure professionals with pristine credit histories remain locked out.

A reversal of the loose lending practices that led to the banking industry's current woes was certainly expected.

But some economists and mortgage brokers say lending standards have become overly restrictive, possibly exacerbating the credit crunch and helping push down home prices further.

Lou Barnes, a mortgage banker in the US, said: “Underwriting criteria have swung from foolish ease to tighter than any in modern times.”

The changes are increasingly frustrating for a group of borrowers whom banks once coveted: affluent self-employed professionals such as doctors, lawyers, accountants and small-business owners.

Hubert Noguera, a 38-year-old medical device engineer who also owns a small business, is one of them. He has not been able to get approval for a loan, despite a strong 800 credit score and a willingness to make a 40 per cent down-payment on a house near San Francisco in the $US800,000-900,000 range.

Mr Noguera said he had assets worth three times the $US500,000 ($777,000) loan he has requested and was in the process of selling his share of a recently inherited California residence worth $US1.1 million.

His mortgage broker, Connie Madrid, said banks turned down the loan because the amount he requested appeared to be high, relative to the portion of his income that he can fully document, and they did not consider his other income.

“My blood type is O positive. What else do they want?” Mr Noguera recalled asking Ms Madrid.

The chief problem for self-employed people is that they don't have appropriate documentation of their full wages. For proof of income, they must rely solely on their income tax returns. But income for the self-employed is often understated for tax purposes, in part because they tend to take large business-related deductions. Self-employed borrowers who don't take any big deductions are not likely to face the same difficulty getting a loan.

Richard Redmond, a mortgage broker in California, said: “When you're self-employed, the write-offs that you use help at tax time - but that means that when you apply for a loan, your income won't reflect your cash flow.”

Lenders are also cautious because non-salaried workers may experience greater volatility in their annual income.

In the past, most self-employed people took out “stated-income loans”, which don't require borrowers to fully document their income. Such borrowers typically made substantial down-payments, had strong credit profiles and paid a slight premium (around 0.25 percentage points) on their interest rates. Defaults were low.

That changed as the loans grew in popularity during the housing boom and expanded beyond their traditional market of affluent professionals. Stated-income loans eventually became disparaged as “liar's loans” because borrowers' incomes were frequently exaggerated.

Many banks have eliminated stated-income loans entirely, and Freddie Mac, which with Fannie Mae is one of two government-held buyers of mortgages, will end its stated-income lending program designed for self-employed borrowers next month.

Peter Ogilvie, past president of the California Association of Mortgage Brokers, said: “If the market stays as it is, we've frozen thousands and thousands of good borrowers out of the mortgage market.

“People who've demonstrated they can pay their bills cannot get a mortgage and that's people who have homes.”

Mr Noguera's loan hasn't been approved because he receives part of his income from a human resources consulting business that he also inherited last year, but lenders won't count income from the firm because he doesn't have two years of reported earnings.

Ms Madrid said: “Six months ago, I know I could have done this, no problem.” She said that even the loan officer at Wells Fargo, for example, was surprised that the loan couldn't be approved.

A Wells Fargo spokesman wouldn't comment on the particular case, but said in a statement: “Like everyone else in financial services, Wells Fargo has adjusted underwriting standards to effectively manage risk in this difficult credit environment.”

This part of the market is tightening despite the Government's attempts to jump-start mortgage activity. Earlier this year, it approved larger loan limits for Fannie Mae, Freddie Mac and the Federal Housing Administration.

Last week, the Government announced it would buy $US600 billion worth of mortgage-backed securities and debt from Fannie and Freddie, which helped push down mortgage rates on government-backed loans by a third of a percentage point.

Self-employed borrowers aren't the only ones finding themselves shut out despite having good credit and savings.

Lenders have also sharply tightened requirements for so called jumbo loans, which are too big to qualify for government backing. That's because banks are relying heavily on loans guaranteed by Fannie and Freddie and the FHA, which have loan limits that vary by market from $US417,000 to $US729,000. Government backed lending now accounts for 87 per cent of loan volume, according to Inside Mortgage Finance, a trade publication.

At JP Morgan Chase, for example, more than 95 per cent of mortgage originations are now sold to a government agency. In certain distressed markets, such as South Florida, JP Morgan won't go above a 60 per cent loan-to-value on jumbo mortgages.

Overall, jumbo-loan originations declined 71 per cent to $US87 billion in the first nine months of 2008, from $US303 billion during the same period last year, according to Inside Mortgage Finance.

Those who can get a jumbo loan are finding them very expensive. Rates on jumbo loans averaged 7.49 per cent last week, nearly 1.6 percentage points above the rates on loans eligible for government backing. According to HSH Associates, financial publishers in Pompton Plains, the gap widened from 1.3 percentage points two weeks ago. In July 2007, the gap between the two was as little as one quarter of a percentage point.

Mike Castrichini, a chiropractor, has been caught between the tightened jumbo market and the disappearance of stated-income loans, which he said he has used for more than a decade without any problem.

He has been unable to find a lender willing to refinance the $US900,000 adjustable-rate mortgage on his primary residence, which he said is worth around $US1.1 million now, down from $US1.8 million a few years ago. Steve Walsh, his mortgage broker, said, “Nobody will touch the loan.”

The 42-year-old Mr Castrichini, who has a solid 787 credit score, owns his two offices and a small strip mall in Illinois. Even if he's approved for the loan, he laments the fact that he is facing a much higher interest rate. “I'm going to have to cut back,” he said, expressing concern that he'll be unable to keep his children in private school.

Banks, meanwhile, are tightening their requirements beyond those of Fannie and Freddie. JP Morgan, for instance, has set tighter standards than the agencies for loans that exceed 80 per cent of the home's value and has stopped making loans for second homes and condos in Florida, according to a recent investor presentation.

“No one wants to be stuck with a loan,” says Mr Walsh, the Arizona broker. He said that underwriters he has worked with have been told they'll be fired if a loan they have originated can't be sold to Fannie, Freddie or the FHA.

Lenders have tighter standards than government agencies because they “usually have a more granular understanding of where credit losses are coming from”, says Sanjiv Das, chief executive of Citigroup's CitiMortgage unit. Lenders said they were also concerned that Fannie and Freddie would force them to repurchase delinquent loans.

Brokers said there was little that borrowers could do to improve their chances of getting a loan right now, but that they could prepare themselves once guidelines eased. The most important steps include maintaining a stellar credit rating and being able to show liquid assets.

Borrowers who can't get a jumbo loan will have a better chance at getting a so called conforming loan - one not exceeding $417,000 - with a higher ceiling in some markets.

Mr Redmond, the California broker, said he had seen so many rejected borrowers with strong credit that he has set up a $US15 million private lending fund that will target those good credit risks.

He warned that the inability of credit-worthy borrowers to refinance mortgages, particularly those that have rising rates, could spur forced sales and further depress home values.

“Fannie and Freddie can sit on the stoop with buckets of cheap money, but if they have raised the bar too high for the borrowers to get at it, it doesn't matter,” he said.

With Ruth Simon