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player ready...”We regret that we must deny your recent application for credit.”
That quietly gut-wrenching opening is from a ”Notice of Adverse Action Taken and Principal Reasons,” a standard business form used by lenders.
The form includes a list of 19 possible standard reasons for denial, from ”Credit application incomplete” to ”Bankruptcy,” plus three lines for
”Other.”
The reasons reflect the range of elements in a loan application that are reviewed by a lending underwriter who decides whether a loan should be granted or rejected.
Because most lenders sell their mortgages to the secondary market dominated by Fannie Mae and Freddie Mac, their underwriting criteria are likely to conform to guidelines issued by Fannie Mae and Freddie Mac, though lenders may differ in how they interpret the guidelines.
The underwriting standards are the focus of new attention because lending industry officials, under pressure because of figures showing higher loan denial rates for minorities than whites, say the denials have resulted from the impartial imposition of those standards rather than discrimination.
According to Paul Gawin, director of the mortgage banking division for Cole Taylor Bank, the key underwriting factors can be boiled down to a handful. A Tribune analysis of 193,175 mortgage applications made in the Chicago area in 1990 showed that these factors are indeed the leading reasons for rejections.
– The ability to establish a good credit history. The Tribune analysis showed that this was the leading reason for rejections, appearing as a reason on 6,185 of 22,066 denials in the six-county region (28 percent).
– The ratio of debt to income. This was ranked second, appearing on 4,246 applications (19 percent).
– The adequacy of the collateral, which depends on the appraisal of the property. This showed up 2,026 times (9 percent).
– The amount of money available for a down payment. This was cited 611 times (3 percent).
– The stability of employment. This was cited 598 times (3 percent).
– The stability of income.
– New housing payment relative to current housing payment. Neither of these last two categories was among those required to be reported to the government.
Elements like these can be reduced to two basic standards that determine whether a loan is worth investing in, Gawin said: ”The likelihood of timely repayment and the possibility of a recapture of capital.”
Gawin gave an example of a loan application handled by his bank that was first rejected and then granted, to explain how underwriting works in practice.
The couple filing the application wanted a 5 percent down payment loan to buy a $55,000 house in Chicago`s West Englewood neighborhood.
He had worked in maintenance with a public agency for eight years, she had been a teacher for two years and together their income was about $3,100 a month, or $37,200 a year.
They qualified in respect to employment stability, since the standard is two years in the same field, Gawin said. And their debt-to-income ratios were well within the guidelines.
Commonly used ratios are a maximum of 28 percent of total income going to housing expenses and 36 percent to all expenses. Cole Taylor and other lenders are willing to exceed the 28/36 standard, but Gawin declined to be more specific. The applicants had excellent ratios of 15 and 25 percent.
So far, the loan looked good. But there were two problems. First, a credit report showed that the couple had been 30 days late with payments 10 times within the previous six months, 60 days late once and 90 days late once. Underwriters typically look most closely at credit history within the previous six months or a year.
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In addition, a student loan had been reported 90 days late 10 times before it was ultimately repaid in full in 1991. ”Student loans are notorious,” Gawin noted.
Still, because the debt ratios were so good, the questionable credit history wouldn`t have been enough to warrant denial of the loan, Gawin said. He pointed out that the couple was paying $435 in rent, had been in good standing with rent payments and would be paying only $483 on the new mortgage. ”We rarely just reject on adverse credit,” Gawin said. But he added that if applicants show a ”consistent pattern of a demonstrated inability to consider credit as part of their responsibility,” the bank will ask for a letter of explanation.
What finally caused the denial for the couple was a lack of down payment, which was created by a peculiar situation. The couple had saved $2,400, almost enough for the $2,750 needed for a 5 percent down payment on the loan for the $55,000 house.
But the appraisal came in at only $50,000. Since lenders take whichever is the lower figure between the purchase price and the appraisal to base the loan on, that meant the bank would only fund the loan at 95 percent of $50,000, or $47,500. Consequently, the couple would have to come up with a down payment of $7,750 instead of $2,750.
To sum up, the denial was based on insufficient down payment that resulted from a below-price appraisal. Such appraisals crop up frequently in low-income and minority neighborhoods.
The story had a happy ending, however. Through the intervention of Neighborhood Housing Services of Chicago, a non-profit group working in several minority and lower-income communities, the seller was induced to lower the home price to $50,000.
At the same time, the couple saved the extra $350 to make up the $2,750 down payment and got the loan.