Mortgage mayhem: Lenders pull gov’t loans, refuse to lock, and raise credit score minimums

Wait — what's going on in the mortgage market right now?

Last week, the Federal Reserve offered assurance to lenders who were struggling to price mortgage rates.

There’s no question this was helpful. 30-year mortgage rates responded by dropping to just 3.33% average for the week, nearing the all-time low from a few weeks ago.

In any other environment, that would be great news for home buyers and refinancers.

But right now? Not so much.

Lenders are acting unpredictably as they face challenges they’ve never experienced before. It’s getting harder for them to make good loans and stay profitable.

In turn, borrowers are facing bigger and bigger hurdles.

Entire loan programs are disappearing, lenders are raising credit score minimums, and some won’t even lock your rate.

Here’s how to make sense of it all.

Lenders are tightening credit standards

As the economy continues to act erratically, many lenders are forced to take their own actions to help sustain themselves.

Lenders are making significant changes to FHA, VA and USDA loans. These changes could make home loans unavailable for mortgage borrowers who could have qualified just weeks earlier.

Some lenders have completely withdrawn government-backed loans — refusing to offer them at all for the time being.

And lenders that are still in the game have upped their minimum credit score requirements by as much as 100 points. To give just a few examples:

• Wells Fargo has adjusted its minimum score requirement to 680 for all government loans (FHA, VA, and USDA)
• US Bank also requires a 680 credit score for FHA, VA, and USDA loans, and 640 for conventional loans
• loanDepot is requiring a 620 minimum FICO score for VA and FHA loans with a higher score (660+) for cash-out or streamline refinancing
• Flagstar is requiring a 640 score for both purchase transactions and non-cash out refinances

Many other lenders are at 660 minimum for these types of loans.

While some lenders are still offering mortgage loans with scores as low as 620, many are setting standards so high that very few fit into the small window of eligibility.

For example, many lenders advertising a 620 credit score are doing so only if you can meet certain requirements. For example, you might need:

• At least two month’s worth of payments in the bank
• No gift funds allowed for down payment or closing costs
• No non-owner occupants without a 680 credit score

For many people who choose government-backed loans like FHA or VA, the looser qualification guidelines are a big draw.

The more stringent requirements lenders are putting in place could make home loans inaccessible for many until coronavirus fears calm down.

Some mortgage companies won’t let you lock at today’s rates

Mortgage lenders are tightening their rate lock requirements too.

Many won’t allow mortgage borrowers to lock until their loan is clear to close.

Effectively, that means you might not know what your mortgage rate is until you’re ready to sign your final papers days before the loan is completed and potentially week or months after you applied.

You might not know what your mortgage rate is until you’re ready to sign your final papers.

For many refinancers, that could make the point of refinancing moot, if their rate isn’t low enough to justify the closing costs.

And for buyers, a high rate could mean starting the loan shopping process again from ground zero.

Other lenders refusing to lock rates at all until the volatility slows down.

How the bailout could cripple the mortgage industry

You might wonder why lenders are cracking down so much on new borrowers.

Isn’t the Fed offering mortgage bankers huge bailouts? And wouldn’t lenders want more business in a time when many industries are going under?

Well, it’s not quite that simple.

The Fed’s unprecedented $183 billion purchase of mortgage-backed securities recently was meant to drive down mortgage rates. And, it worked.

However, mortgage servicers are now facing a difficult position as more homeowners elect to suspend payments during the crisis.

When a homeowner misses a payment, servicing companies are contractually obligated to advance payments to investors in securities markets.

The Mortgage Bankers Association warns that the U.S. housing market is “in danger of large-scale disruption,” due to efforts by the Federal Reserve that were intended to help rescue the mortgage market.

In other words, you’re not paying your mortgage company, but it still has to pay its own creditors.

A flood of missed mortgage payments is threatening to bankrupt U.S. mortgage lenders, deepening the economic toll of the pandemic.

The Mortgage Bankers Association (MBA), in a dismal letter to regulators, warned that the U.S. housing market is “in danger of large-scale disruption,” due to efforts by the Federal Reserve that were intended to help rescue the mortgage market.

>> Related: How to pause mortgage payments if you lost your job due to COVID-19

What’s happening to mortgage companies behind the scenes

This is where it gets technical.

The Feds forcefully entered the mortgage market a couple of weeks ago — in part, to combat rising rates. And in part, because of a fear that borrowers wouldn’t be able to pay their loans.

All told, the Fed has purchased $250 billion in mortgages over the past two weeks.

That’s $84 billion more than the Fed had bought over any four-week period during the financial crisis in 2009.

While the Fed helped drive rates down, they also blew up a widespread “hedge” that mortgage lenders use to protect themselves against rate increases.

Hedging pays lenders if the prevailing rate in the market is higher than the mortgage rate they locked in with the customer.

Normally, hedging is considered to be a safe trade. The hedge simply protects the lender against higher rates until the mortgage closes.

This system works well, most of the time.

But when mortgage rates are highly volatile — as they’ve been these past weeks — it’s difficult for lenders to use the same hedging strategy.

And, compounding the problem, many would-be homeowners couldn’t close on their loans because of quarantines.

Locking lots of loans that didn’t close left mortgage lenders with only the cost of the hedge and no income from the loan closing.

The huge volatility in mortgage bonds created massive margin calls from the broker-dealers, who wrote the hedges, to their mortgage bankers.

According to Barry Habib, founder of MBS Highway, “Some of these mortgage bankers are now facing margin calls of tens of millions of dollars that could drive them out of business.”

In its letter to regulators, the MBA said: “The dramatic price volatility in the market for agency mortgage-backed securities [MBS] over the past week is leading to broker-dealer margin calls on mortgage lenders’ hedge positions that are unsustainable for many such lenders.”

The letter went on to say, “Margin calls on mortgage lenders reached staggering and unprecedented levels by the end of the week. For a significant number of lenders, many of which are well-capitalized, these margin calls are eroding their working capital and threatening their ability to continue to operate.”

While the stock market is playing a game of Chutes and Ladders, lenders are scurrying to find ways to continue to successfully operate in foreign territory.

What should you do if you’re trying to get a mortgage?

The roller coaster ride that mortgage lenders are experiencing isn’t all doom and gloom for you.

In fact, there is a bit of a silver lining for mortgage borrowers. Until the economy settles down, mortgage lenders are trying to balance how much to pull back vs making good loans.

Not all lenders are reacting the same way.

This means some lenders have not instituted minimum score requirements as low as their competitors. Some lenders may not be hedging as much as others, which means lower rates.

Now more than ever before, mortgage borrowers should shop around until they find a lender that can fit your needs.

>> Related: How to shop for a mortgage and compare rates

Questions you should ask a mortgage lender right now

If you’re currently in the market for a loan, you’ll want to make sure you’re asking your lender plenty of questions:

• What are your minimum credit score requirements?
• How long do you expect it to take from application to closing?
• At what point can I lock my rate and for how long?
• What happens if my loan doesn’t close within the allotted rate lock period?
• Who will be responsible for rate extension fees if my loan doesn’t close on time?
• Do you have a float-down policy if rates drop significantly after locking?
• Is the rate you’re quoting me include any discount points?

Unlike the housing crash a decade ago, the housing and mortgage markets are much healthier now.

Homeowners have a record amount of equity, so there’s less risk of home values dropping far enough to put many homeowners underwater (like what happened during the subprime mortgage crisis).

Is it a good time to act on low rates?

Say you find a low rate, and a lender that’s still offering favorable loan terms.

Even then, you should weigh the decision of taking out a new loan carefully.

How stable is your job looking right now? How much do you have in savings? And if you were to become unemployed, could you still make the mortgage payment?

Some borrowers might stand to benefit from today’s low rates, but it’s certainly not the right time for everyone.

Rates will likely stay low even after this crisis is over, so don’t think staying on the safe side will backfire. Make the decision that’s best for you.