Which one of these clients would you rather lend money to? Which one would you expect would pay a higher mortgage rate? Which loan is harder to get approved? Which loan is more likely to go into foreclosure?
Client A: This client is Joe Sixpack and a first time home buyer purchasing a $250,000 home in the West Podunck and has five percent to put down. However, a five percent down payment will only leave him with about $2000 in cash after closing, just barely enough to pay movers and maybe by some cleaning supplies at Wal-Mart. He has a 650 FICO score due to a number of late payments on cell phone and credit card bills over the years. His debt ratio is close to 54% which means more than half his income before taxes is going to pay the mortgage and other major debts. He also had a bankruptcy three years ago.
Client B: This client is Joe Ivy League and is buying a home for $600,000 and is putting 
10% down. After the down payment, he will have a little more $1.2 million in remaining in liquid reserves. The borrower works for a major investment bank and makes a base salary of $125,000 per year and has a year end bonus of at least an additional $150k. However, we can't count the bonus income because he recently completed his MBA at arguably the best business school in the country so he hasn't yet received his first year bonus payout although a five second Google search would show all kinds of well respected third party documentation (Wall Street Journal for example) of what first year investment banking associates can expect in total comp. His current home is listed for sale, but no offers so we have to count the carrying cost of the home. When counting the debt from the current home plus the debt from the new mortgage, his debt ratio is about 70% if we exclude his estimated bonus income. Counting his bonus income he can carry both mortgages fairly easily with low debt ratios. Alternatively, not considering the carrying cost of his current home, his debt ratios are well within guidelines even if we ignore his annual bonus.
According to current mortgage pricing models and underwriting guidelines, Client A is the least risky loan. In fact, Client A would have a conforming mortgage of about 6.5% on a 30 year fixed today. This would be an easy deal because I also get an automated approval from Fannie Mae's Desktop Underwriter and Freddie Mac's Loan Prospector.
On the other hand, Client B came to me after their loan was denied by another bank. The problem is two fold. First, underwriting guidelines for traditional mortgages focus more on income than wealth. So even though Client B is clearly a common sense loan, most banks would deny the loan because they can't document enough monthly income to cover the mortgage and existing debts OR because they want to count the current home's mortgage payment in the debt ratios because it has not yet sold (home is listed for sale). Fortunately, I am able to get this deal done as a full documentation loan, but it took several wholesale investors saying no to exceptions before I finally found one. Many that said no, would beg me all day long for Client A's loan.
I know, you are again thinking WTF?
Client B is a victim of over efficiency in the mortgage business. Back in the day before computers, FICOs, CDOs, hedge funds, automated underwriting systems, and call centers, people used to put on a suit and go meet their banker and apply for a mortgage loan. The banker would look at their loan and maybe took it to a credit committee who made a lending decision based on credit, capacity, collateral, and character. In other words, you were more than just a number but a customer of the bank and they tried to assist you financially by making a sound lending decision.
Skipping to 2007, none of that matters anymore. All that matters is can your loan be sold to Wall Street. The system is set up so that FICO scores are king and all loans must fit into a rigid box so they can be packaged and sold. Unfortunately, because of the volume of loans and so many investors are buying pools of mortgages, it leaves no room for common sense underwriting. Underwriting mortgages isn't about making good loans anymore. It is about making sure loans can be sold which leaves us with situations above where a documentable millionaire can't get a mortgage, but a guy living check to check with a three year old bankruptcy qualifies for the lowest rates in the market.
I believe respected mortgage blogger, Brian Brady called this the mortgage tax. The good is paying for the bad. I call it stupid underwriting. It isn't about needing a stated income loan or needing some other non-traditional mortgage product. It is about someone actually being required to think and make a common sense lending decision based on the facts at hand, not whether we can fit into a product matrix and the risk models.
Mortgage banks and lenders need to go back to actually sitting down with each client individually and making rational and logical lending decisions.
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Sadly this is so true, the mortgage business is about "do you fit this or do you fit that?" not "does this actually make sense?" Because if client A came to me and said "Rick, would you let me borrow $100k" I would probably laugh at him and if client B said the same thing I'd happily sign over $100k to him because it just makes sense. Its obvious that he is able to repay that money. Sadly the computers can't see that...Good blog as always Russ