Ghost of A Crisis Past

photo by Chandres

The Royal Bank of Scotland settled an investigation brought by New York Attorney General Schneiderman arising from mortgage-backed securities it issued in the run up to the financial crisis. RBS will pay a half a billion dollars. That’s a lot of money even in the context of the settlements that the federal government had wrangled from financial institutions in the aftermath to the financial crisis. The Settlement Agreement includes a Statement of Facts which RBS has acknowledged. Many settlement agreements do not include such a statement, leaving the dollar amount of the settlement to do all of the talking. We are lucky to see what facts exactly RBS is “acknowledging.”

The Statement of Facts found that assertions in the offering documents for the MBS were inaccurate and the securities have lost billions of dollars in collateral. These losses led to “shortfalls in principal and interest payments, as well as declines in the market value of their certificates.” (Appendix A at 2)

The Statement of Facts outlines just how RBS deviated from the statements it made in the offering documents:

RBS’s Representations to Investors

11. The Offering Documents for the Securitizations included, in varying forms, statements that the mortgage loans were “originated generally in accordance with” the originator’s underwriting guidelines, and that exceptions would be made on a “case-by-case basis…where compensating factors exist.” The Offering Documents further stated that such exceptions would be made “from time to time and in the ordinary course of business,” and disclosed that “[l]oans originated with exceptions may result in a higher number of delinquencies and loss severities than loans originated in strict compliance with the designated underwriting guidelines.”

12. The Offering Documents often contained statements, in varying forms, with respect to stated-income loans, that “the stated income is reasonable for the borrower’s employment and that the stated assets are consistent with the borrower’s income.”

13. The Offering Documents further contained statements, in varying forms, that each mortgage loan was originated “in compliance with applicable federal, state and local laws and regulations.”

14. The Offering Documents also included statements regarding the valuation of the mortgaged properties and the resulting loan-to-value (“LTV”) ratios, such as the weighted-average LTV and maximum LTV at origination of the securitized loans.

15. In addition, the Offering Documents typically stated that loans acquired by RBS for securitization were “subject to due diligence,” often described as including a “thorough credit and compliance review with loan level testing,” and stated that “the depositor will not include any loan in a trust fund if anything has come to the depositor’s attention that would cause it to believe that the representations and warranties of the related seller regarding that loan will not be accurate and complete in all material respects….”

The Actual Quality of the Mortgage Loans in the Securitizations

16. At times, RBS’s credit and compliance diligence vendors identified a number of loans as diligence exceptions because, in their view, they did not comply with underwriting guidelines and lacked adequate compensating factors or did not comply with applicable laws and regulations. Loans were also identified as diligence exceptions because of missing documents or other curable issues, or because of additional criteria specified by RBS for the review. In some instances, RBS disagreed with the vendor’s view. Certain of these loans were included in the Securitizations.

17. Additionally, some valuation diligence reports reflected variances between the appraised value of the mortgaged properties and the values obtained through other measures, such as automated valuation models (“AVMs”), broker-price opinions (“BPOs”), and drive-by reviews. In some instances, the LTVs calculated using AVM or BPO valuations exceeded the maximum LTV stated in the Offering Documents, which was calculated using the lower of the appraised value or the purchase price. Certain of these loans were included in the Securitizations.

18. RBS often purchased and securitized loans that were not part of the diligence sample without additional loan-file review. The Offering Documents did not include a description of the diligence reports prepared by RBS’s vendors, and did not state the size of the diligence sample or the number of loans with diligence exceptions or valuation variances identified during their reviews.

19. At times, RBS agreed with originators to limit the number of loan files it could review during its due diligence. Although RBS typically reserved the right to request additional loan-level diligence or not complete the loan purchase, in practice it rarely did so. These agreements with originators were not disclosed in the Offering Documents.

20. Finally, RBS performed post-securitization reviews of certain loans that defaulted shortly after securitization. These reviews identified a number of loans that appeared to breach the representations and warranties contained in the Offering Documents. Based on these reviews, RBS in some instances requested that the loan seller or loan originator repurchase certain loans. (Appendix A at 4-5)

Some of these inaccuracies are just straight-out misrepresentations, so they would not have been caught at the time by regulators, even if regulators had been looking. And that’s why, ten years later, we are still seeing financial crisis lawsuits being resolved.

It is not clear that these types of problems can be kept from infiltrating the capital market once greed overcomes fear over the course of the business cycle. That’s why it is important for individual actors to suffer consequences when they allow greed to take the driver’s seat. We still have not figured out how to effectively address tho individual actions that result in systemic harm.

Can I Refinance?

photo by GotCredit.com

LendingTree quoted me in Can I Refinance? Refinance Requirements for Your Mortgage. It opens,

While there are many reasons to refinance a mortgage, one of the biggest factors at play is whether or not you’ll be able to get a better interest rate. When interest rates drop, homeowners are incentivized to refinance into a new mortgage with a lower rate and better terms because it can potentially save them a boatload of money over the course of their loan.

Not only can refinancing save money on interest payments, but it can lead to lower monthly payments, or be a way to get rid of a pesky primary mortgage insurance requirement once you’ve earned enough equity in your home. Homeowners can also tinker with their repayment timeline when they refinance, choosing to lengthen their loan term or even shorten it to pay off their home faster.

The first question before you refinance your mortgage is simple: Does it make financial sense? Refinancing a mortgage comes with the same closing costs and fees as a regular mortgage, so you must stand to earn more by refinancing than you’ll pay to do it.

If you’ve had the same mortgage rate since the aughts or earlier, chances are you could have much to gain by refinancing in today’s lower rate environment.

The average interest rate on a 30-year, fixed-rate mortgage hit a low point of 3.31% on Nov. 21, 2012 and hasn’t budged all too much since then. Rates currently stand at 4.32% as of Feb. 8, 2018. By comparison, rates were routinely in the double digits in the 80s and early 90s.

Will rates continue on the upward trend? Unfortunately, nobody knows. But rate behavior will very likely play a key role in your decision.

Once you’ve decided refinancing makes financial sense, the next question should be this: What does it take to qualify? That’s what we’ll cover in this guide.

If you hope to refinance before rates climb any further, it’s smart to get your ducks in a row and find out the refinance requirements for your mortgage right away. Keep reading to learn the minimum requirements to refinance your mortgage, how your credit score may come into play and what steps to take next.

Can you refinance your home?

Lenders consider three main criteria when approving consumers for a home refinance – income, equity, and credit.

  • Debt and income.
  • Equity. Equity is important because lenders want to confirm possibly getting their money back out of your home if you default on your mortgage.
  • Credit. Any lending situation will involve a credit check. “They look at your credit score to see if you have the willingness to pay your mortgage back – to see if you’re creditworthy,” said David Reiss, Professor of Real Estate Law at The Center for Urban Business Entrepreneurship at Brooklyn Law School. “Do you have a low credit score or a high credit score? Do you pay your bills on time?” he asked. “These are all things your lender needs to know.”

While the above factors play a role in whether you’ll qualify to refinance your home, lenders do get fairly specific when it comes to how they gauge your income to determine affordability. Since the amount of income you need to qualify for a new mortgage depends on the amount you wish to borrow, lenders typically use something called “debt-to-income ratio” to measure your ability to repay, says Reiss.

Your debt-to-income ratio (DTI)

During the underwriting process for a conventional loan, lenders will look at all the factors that make them comfortable extending you a loan. This includes your income and your debt levels, says Reiss. “Debt-to-income ratio is an easy way for lenders to determine if you have too many debt payments that might interfere with your home mortgage payment in the future.”

To come up with a debt-to-income ratio, lenders look at your debts and compare them with your income.

But, how is your debt-to-income ratio determined? Your debt-to-income ratio is all of your monthly debt payments divided by your gross monthly income.

In the real world, someone’s debt-to-income ratio would work something like this:

Imagine one of your neighbors has a gross monthly income of $4,000, but they pay out $3,000 per month toward rent payments, car loans, child support, and student loans. Their debt income ratio would be 75% because $3,000 divided by $4,000 is .75.

Reiss says this factor is important because lenders shy away from consumers with debt-to-income ratios that are considered “too high.” Generally speaking, lenders prefer to loan money to borrowers with a debt-to-income ratio of less than 43% but 36% is ideal.

In the example above where your neighbor has a monthly gross income of $4,000, this means he or she may have to get all debt payments down to approximately $1,700 to qualify for a mortgage. ($1,700 divided by $4,000 = .425 or 42.5%).

There are exceptions to the 43% DTI rule, according to the Consumer Financial Protection Bureau. Some lenders may offer you a mortgage if your debt-to-income ratio is higher than 43%. Situations, where such mortgages are offered, include when a borrower has a high credit score, a stellar record of repayment or both. Still, the 43% rule is a good rule of thumb to follow when it comes to traditional mortgages.

Other financial thresholds

If you plan to refinance your home with an FHA mortgage, your housing costs typically need to be less than 29% of your income while your total debts should be no more than 41%.

However, the U.S. Department of Housing and Urban Development, which oversees FHA loans, also notes that potential borrowers with lower credit scores and higher debt-to-income ratios may need to have their loans manually underwritten to ensure “adequate consideration of the borrower’s ability to repay while preserving access to credit for otherwise underserved borrowers.”

Mortgage broker Mark Lewin of Caliber Home Loans in Indiana even says that in his experience, individuals with good credit and “other compensating factors” have secured FHA loans with a total debt-to-income ratio of 55%.

Of course, those who already have an FHA loan may also be able to refinance to a lower rate with no credit check or income verification through a process called FHA Streamline Refinancing. Your debt-to-income ratio won’t even be considered.

A VA loan is another type of home loan that has its own set of debt-to-income requirements. Generally speaking, veterans who meet eligibility requirements for the program need to have a debt-to-income ratio at or below 41% to qualify. However, you may be able to refinance your home with an Interest Rate Reduction Refinance Loan from the VA if you already have a VA loan. These loans don’t have any underwriting or appraisal requirements.

Equity requirements

Equity requirements to refinance your mortgage are typically at the sole discretion of your lender. Where some home mortgage companies may require 20% equity to refinance, others have much lighter requirements.

To find out what your home is worth and how much equity you have, you typically need to pay for a home appraisal, says Reiss. “Appraisals are typically required because you have to be able to prove the value of your home in order to refinance, just like you would with a traditional mortgage.”

There are a few exceptions, however. Mortgage refinancing options that may not require an appraisal include:

  • Interest Rate Reduction Refinance Loans from the VA
  • FHA Streamline Refinance
  • HARP (Home Affordable Refinance Program) Mortgages

Explaining loan-to-value ratio, or LTV

Loan-to-value ratio is a figure determined by assessing how much you owe on your home in relation to its value. If you owe $80,000 on a home worth $100,000, for example, your LTV would be 80% and you would have 20% equity in your home.

This ratio is important because it can determine whether your lender will approve you for a refinance. It can also determine the interest rates you’ll pay and other terms of your loan. If you have less than 20% equity in your home, for example, you may face higher interest rates and fees when you go to refinance.

Having less than 20% equity when you refinance may also cause you to have to pay PMI or private mortgage insurance. This mortgage insurance usually costs between 0.15 to 1.95% of your loan amount each year. If you have less than 20% equity in your home already, you’re already likely to be paying for this coverage all along. However, it’s still worth noting that, if you refinance with less than 20% equity, this coverage will once again get tacked onto your mortgage amount.

Is 80% LTV mandatory?

Your LTV and equity aren’t the end-all, be-all when it comes to your loan refi application. In fact, Reiss says that lenders he has experience with don’t absolutely require borrowers to have 20% equity or a loan-to-value ratio of 80% — so long as they score high on other measures.

“If you meet the lender’s requirements in terms of income and credit, your loan-to-value ratio doesn’t matter as much — especially if you have excellent credit and a solid payment history,” he said. However, lenders do prefer lending to consumers who have at least 20% equity in their homes.

Reiss says he always refers to 20% equity as the “gold standard” because it’s a goal everyone should shoot for. Not only does having 20% equity in your home when you refinance help you avoid paying for the added expense of PMI, but it can help provide more stability in your life, says Reiss: “Divorce, disease, and death in the family can and do happen, but having equity in your home makes it easier to overcome anything life throws your way.”

For example, having more equity in your home makes it easier to refinance into the best rates possible. Having a lot of equity is also ideal when you have to sell your home suddenly because it means you’re more likely to turn a profit and less likely to take a loss. Last but not least, if you have plenty of equity in your home, you can access that cash for emergency expenses via a home equity loan or HELOC.

“Home equity is a big source of wealth for American families,” he said. “The more equity you have, the more resources you have.”

Fortunately, many households are enjoying greater home equity today, as home values have continued to increase since the housing crisis.

Your credit score

The third factor that can impact your ability to refinance your home is your credit score. When a lender decides whether to give you a mortgage or not, they typically offer the best rates to people with very good credit, or with FICO scores of 740 or higher, according to Reiss.

“The lower your credit score, the higher your interest rate may be,” he said. “If your credit score is bad enough, you may not be able to refinance or get a new mortgage at all.”

The FICO scoring model’s main website, myFICO.com, seems to echo Reiss’ comments. As it notes, a “very good” score is any FICO score in the 740-799 range. If you earn a 740+ FICO, you’re above the national average and have a greater likelihood of getting credit approval and being offered lower interest rates.

Don’t stress about getting a perfect 850 FICO score either. In reality, rates stop improving much once you pass 740.