For mortgage seekers, it's back to the basics

By Dina ElBoghdady
The Washington Post

WASHINGTON - An abrupt shift back to the basics of mortgage lending has many house hunters nervous because several once-popular types of loans are disappearing.

With urging from regulators, lenders faced with growing piles of bad loans have clamped down on the kinds of mortgages they are willing to offer. That is most strongly affecting people who lack proof of income, cash reserves or good credit. But others should still be able to find a home loan.

"If all three of these elements are in place, it's basically business as usual," said Greg McBride, senior financial analyst at Bankrate.com. "But, as in any environment, the best way to shop for a mortgage is not just shooting one arrow."

In other words, speak to several lenders and several mortgage brokers, who act as liaisons between lenders and consumers. The Federal Trade Commission advises comparing and negotiating for a mortgage as you would when buying a car.

But first, understand the basics of what it takes to get a mortgage.

For starters, find out if the lender requires a down payment and if so, how much you can afford.

Most house hunters must once again bring money to the table because the no-down-payment loans that four out of 10 first-time home buyers used during the boom years are hard to come by. Many lenders now want at least 5 percent down - and the more, the better.

Also consider whether you will be required to buy private mortgage insurance (PMI), which protects the lender if the borrower fails to pay. If so, ask how much that would add to your monthly payment. PMI is required by most lenders if a loan exceeds 80 percent of a home's value.

To avoid PMI, many cash-strapped borrowers used "piggyback" mortgages in recent years, meaning they took out two loans. The first covered 80 percent of the cost of the home, and the second was typically a home-equity line of credit that covered the balance or at least part of it.

Many lenders have stopped making piggyback loans because the second loan poses more risk than they are willing to take. If a homeowner loses a house, proceeds from its sale would go toward paying off the first mortgage. Usually, there would be little, if any, money left to cover the second.

Also out of favor, and nearly impossible to find, are low- or no-documentation loans, which had been devised for people who were unwilling or unable to verify their incomes.

No matter what type of loan a house hunter has in mind, the one thing most lenders are increasingly focused on is the borrower's credit score, said Patricia Mertz Esswein, an associate editor of Kiplinger's Personal Finance magazine.

Lenders rely heavily on that score to assess how likely a person is to repay a mortgage on time. The more risk potential home buyers pose, the less likely they are to get loans at the lowest interest rates and with the best terms - if they can get loans at all.

Loans available to people with credit scores of 660 just months ago are no longer available, Esswein said.

"What people may want to do is take the time to improve their credit score before they start looking for a mortgage," she said. "It will increase the options available to them and improve the rate that a lender will be able to offer them."

But even borrowers with good credit need to carefully weigh their options if they're taking out a loan for more than $417,000, known as a jumbo loan.

Fannie Mae and Freddie Mac, the largest investors in U.S. mortgages, by law can purchase or guarantee loans for single-family houses up to that amount. The limit is determined annually by federal regulators based on the average home price nationwide.

Loans that exceed that limit, and therefore do not conform to Fannie and Freddie standards, have fallen out of favor with investors because they are perceived to be more risky than conforming loans.

When investors yanked their money out of the nonconforming market, many firms specializing in jumbo loans were left with little money to fund mortgages.

Some shut down, stopped making such loans or got more selective about who gets them.

Others simply raised their rates, in part to offer investors a better return for their money. That led to a widening gap between jumbo and conforming loans, making the former more expensive.

People with good credit, a down payment and proof of income can still get a jumbo loan, McBride said. "It just comes at a higher price relative to smaller loans."