How Tight Are Mortgage Underwriting Standards, Really?

The WSJ's Jonathan Karp wants to tell us "How the Mortgage Bar Keeps Moving Higher", in the words of his headline. After all, he says, "mortgage lenders are tightening standards, even for borrowers with strong credit". We've known this for a while, of course, but cut the chap some slack: he's writing for the Personal Journal.

Naturally, Mr Karp needs to kick off the story with an anecdotal example of underwriting standards tightening up. Does he find a hardworking executive with an embarrassing past which is hurting his FICO score? A young couple with a good double income who have just blown a bundle on their wedding and therefore don't have a lot of money for a downpayment? Not exactly. Rather, he finds Frankie Van Cleave, a 70-year-old denizen of Marietta, Georgia, who already lives in her $890,000 riverfront property.

Now 70-year-olds are not the kind of people that mortgage lenders naturally court at the best of times. Their future income is unlikely to go up, and indeed is highly likely to go down. They're at very high risk of enormous medical bills, or death. In other words, their ability to make mortgage payments over the course of 15 years or more is likely to be limited.

But if the home in question is valuable enough, and the loan in question is small enough, then banks will still lend the money. So maybe the problem with Ms Van Cleave is that she was asking for too much money. A bank might be willing to lend her half the value of her home – $450,000. But if she asked for, say, 80% of the value – $720,000 – you can see why a lender would say no.

So how much is Ms Van Cleave asking for? A cool $1 million, or more than 110% of the appraised value of her home. Never mind the risk that house prices might drop: in order for any such lender to have the remotest chance of being paid back in full, Frankie's house will have to rise, and quite substantially too, in value. But that's not the way she sees it, of course:

"A good credit record doesn't count for anything now," Ms. Van Cleave says of her futile refinancing effort. "If you don't have assets, forget it. If you're self-employed, you have real problems in this market."

No. If you're 70 years old, and you have $110,000 of negative equity, then you have real problems in this market. (Actually, we're told that the appraisals on the house came in below $900,000, which means that she has even more negative equity than that.) The self-employed bit is the least of Van Cleave's worries: no lender is going to assume that a 70-year-old is going to stay on the payroll at any company for very long.

The fact that Frankie Van Cleave can't get a mortgage is not news. It's the fact that "several mortgage brokers" were still courting her not so long ago which is the more worrying part.

Indeed, I wonder whether underwriting standards have in reality tightened up nearly as much as we're constantly being told they have. Look at the most recent tranche of ABX.HE subprime indices, the 07-02 vintage, containing mortgages written in the first half of this year, long after systemic problems in subprime underwriting had been splashed all over the headlines. It turns out that those subprime loans are trading just as badly as – if not worse than – the subprime loans of the 2006 vintage. And does this sound like underwriting standards are tight, or just that they've been insanely loose right up until now?

IndyMac Bancorp is the latest lender to shun 100% financing for borrowers who want merely to state their income. For Alt-A loans that don't have third-party mortgage insurance, IndyMac is insisting on at least a 5% down payment for "all loan sizes and property types," according to guidelines sent to mortgage brokers.

IndyMac has been providing, all year, 100% financing for people who won't even show them how much money they were making? And it's still providing 95% financing? Yikes. This article isn't showing me how tight underwriting standards are: it's showing me how loose they are.

I do think that there's less outright fraud in loan applications now, compared to a year ago. But I'm not convinced that there's been a significant tightening of underwriting standards more generally – certainly not until the past couple of weeks, anyway. And if that's the case, then mortgage lenders have been acting even more foolishly than we'd heretofore imagined.