The Bright Side of Tighter Underwriting Standards
When I first started practicing real estate law many years ago, I remember getting a call from a mortgage broker who was representing my client, the buyer, to give me an update on how the financing was going. “Well,” he started, “we pulled his credit and it was around 620, and this is a no income verification loan,” he continued. This seemed odd to me since my client was a W2 employee with a major pharmaceutical company in NYC. But I was relatively new to the business, so I figured I would just listen. “And of course he is looking for 90% financing on this purchase.” My heart began to sink, thinking I was being prepared for the inevitable, “your deal is going to die because I cannot get your low credit score no income verification client 90% financing.” Instead, I heard him then report “so it looks like we’re good to go and you can schedule the closing for next week.”
“Wow,” I thought, I really don’t understand the mortgage banking business very well.
Turns out I did, and my skepticism was warranted. That loan, and thousands of others like it, never should have been made. Much has been reported and written about the sea change in underwriting standards from that era of free money, and many in the industry blame the lackluster rebound in housing on the very tight credit standards.
But there is a bright side to what is going on today that we often overlook. Our foreclosure and short sale rates today are in large part a reflection of those very loose underwriting standards from yesterday. With the return to banking fundamentals, the quality of current portfolios is far superior to those of just a few years ago, and we will soon reap the benefits of this renewed vigor when those loans in repayment out one or two years exhibit what is surely to be a historically and unprecedented low rate of loan defaults due to the credit quality of today’s borrowers. Moreover, with an increased attention to appraisal standards, and careful review of building financials, the collateral behind these loans will surely perform better than that of yesterday’s loans. The combination of low default rates and high collateral asset quality means that the market for these securities is almost certainly going to be robust once this becomes apparent to the secondary marketplace. That will only lead to lower interest rates as liquidity in the after-market dictates higher demand for these solid assets.
So let’s remember that while it may be more tedious to go through the typical financing in today’s market, we are – hopefully – building a base for a future of lower default rates and higher asset quality of the mortgage backed securities that will emerge from these tough standards.