April 18, 2020 

Last week I wrote about holiday payment programs that allow existing mortgage borrowers who have lost their income as a result of the pandemic to defer their payments without penalty. This article is about potential borrowers who must cope with a much less favorable market for new loans.

Impact of the Pandemic

The housing finance system hasn’t faced one before. Within a very short time, a significant segment of potential home buyers who need mortgages to make their purchases, or to refinance the one they have, have had their ability to repay severely eroded - some because they have contracted the coronavirus but most because they have lost their jobs or their businesses as a result of the pandemic. In response to the widespread deterioration in the ability-to-pay of prospective borrowers, credit standards have been markedly tightened – with the impact especially severe on those with the weakest credit credentials.   

How Bad Is It?

The current disorganization of the home mortgage market is the worst I have ever seen. The mortgage pricing process, where price quotes on mortgage-backed securities (MBS) drive wholesale prices set by large lenders, which drive the retail prices that borrowers see, is completely broken. The price sheets used in these relationships either show massive rate increases or are not being issued. Price lock programs have become extremely costly or shut down altogether.

In an attempt to repair the process, the Federal Reserve has entered the MBS market with massive purchases. Since MBS prices ordinarily drive the entire market price structure, such purchases should have resulted in higher MBS prices and lower mortgage rates, but they haven’t. Of course, they might well have prevented even higher rates.

The required credit score for an FHA loan, which previously had ranged from 620 to as low as 540, is now 680. While the credit risk on FHAs is assumed by the Federal Government, no lender wants to be responsible for submitting loans that will result in large losses to FHA.

Has the Mortgage Holiday Worked?

It has prevented a catastrophic explosion in default rates – for a while. But borrowers will have to make larger payments in the future, or extend the term of their loans.

In the short-term, the firms servicing mortgages that have been pooled into securities are obliged to advance the payments due to the investors holding the securities, whether payments have been received from borrowers or not. The forbearance has made mortgage servicing an unprofitable line of business, which raises the cost of originating new loans, which raises the rates on new loans. On the highest-quality loans, the rate is about .375% higher than before the pandemic hit.

How Potential Borrowers Can Cope

Their options depend on where they are now in the process.

Prospective Home Buyers Who Will Need Mortgages: Those who have become sick, or lost their jobs or their businesses, or had their credit score dropped significantly should put their purchase plans aside until their fortunes improve. Those not directly affected by the pandemic should consider waiting a few months until the market has stabilized and rates are back to where they were before the pandemic. This applies as well to prospective refinancers.

Homeowners in Process of Refinancing: If you have not already locked an advantageous rate, there is little likelihood that it will happen now. Back out to wait for the turbulence to end.

If your rate has been locked advantageously, the lender can unlock it only if you lose your job or if you incur a new debt. Lenders have become hyper-vigilant in checking employment status of borrowers with loans in process.

You are safe, however, against losing an advantageous refinance because your credit score has dropped. Lenders cannot undo the credit score used to qualify you for 120 days.

Home Buyers in Process With Purchase Agreements and Locked Mortgages: Unless you lose your job or increase your debt, the rate lock will be honored and the purchase will be executed.

If one or both of those conditions has been violated, the lock probably will be withdrawn and the purchase will be cancelled. Your best option in that case is having your deposit with the seller returned. That will happen if your agreement of sale provides for the return of a deposit made by a prospective buyer whose failure to execute the transaction is due to a failure of the lender to deliver the promised loan.