Vengeance is sweet, but action is even better. On a presidential initiative that is at least two years overdue, the White House recently made a push with their point man -- Mr. Obama himself, to start sending signals to the mortgage lending industry to lighten up a bit on loan underwriting standards.
Even an erstwhile investor fellow such as myself -- who never saw a new tract home he didn't like, have been yelling from the sidelines the last few years to "adjust" the lending parameters. The reason: In order to lower the barriers of entry into the real estate investment arena, there needs to be a reasonable degree of flexibility. Why? To do so makes the market more accessible for those with noble intentions. And in so doing you clear the market of its excess inventory. Investors are like scavengers. They're not picky, so long as they have something to consume. It's like asking a college student if he doesn't mind cold pizza.
I can barely count the interviews I've given advocating that it's the underwriting stupid. Investors are a hidden supply! And given the degree of many folk whose credit was eviscerated several years ago, the question becomes how do you tap into that target market without stepping on the same land mines.
The Solution
Here's the scenario and rebuilding model: A destroyed credit profile means a low FICO score. A low FICO score means no loan. No loans means a slower moving economy. Forget the adage "Cash is KING." In real estate home sales,"FICO is KING."
How to get a high FICO score -- either prey to Jesus or wait it out. Unfortunately, for most investors, many are agonistic atheists -- if that's even possible, or vice versa. A person, either it be an investor or non-investor, with a bankruptcy, foreclosure or mortgage lates -- or all of the above, will simply have to wait it out. You can try to reconstruct your credit profile, but the market is unforgiving.
However, many in the latter scenario are cash rich. Hence, what to do! If credit poor, but cash rich -- roll back the FICO score element of the underwriting process, but require more cash down.
The solution? Augment the loan underwriting standards to better accommodate to those real life situational scenarios as described above. Which in many cases, you have a guy sitting in the penalty box with a low FICO score in the 500 to 550 range, but has $20,000 invest, which means he has no real chance of buying a home under reasonable circumstances. He can't qualify for a traditional loan. Just try asking someone to sell their home to you and to put it under contract without a traditional loan. Chances are, they won't let you anywhere near escrow. In fact, they might issue a restraining order against you.
In the Washington Post, it was reported that beginning in 2007 through 2012, the purchase of new home sales dropped by 30 percent for home buyers with FICO scores above 780. But for home buyers with FICO scores that fell between 620 to 680, home purchases dropped 90 percent. It should be noted that the latter range is historically a better than average FICO score. This data is from the Federal Reserve.
"If the only people who can get a loan have near-perfect credit and are putting down 25 percent, you're leaving out of the market an entire population of creditworthy folks, which constrains demand and slows the recovery," said Jim Parrott, former senior adviser for the White House's National Economic Council.
What are the alternatives: 1) Go to hard money lenders, with interest rates at 12 percent to 20 percent. 2) No money down scenarios. Which are the legend of late night TV get rich schemes -- and in reality typically involve knocking on some homeowners' door and asking if you can buy their home with no money down with seller financing, and 3) Executing a purchase agreement with a distressed homeowner for an inflated price that is subject to an unnamed buyer buying the house at a future date? (Right).
Obama Charm Playbook
If the Obama charm offense works on the home lending industry, then more buyers -- either it be first-time home owners or small investors, come off the sidelines and will start to buy. Many experienced investors would love to pick-off 3 or 4 homes a year.
Similar to a farmer who is wiped out for two years because bad weather has destroyed his crop, and wherein the government offers subsidies to keep the farmer viable and frontline ready to harvest new crop for the next season, so too are investors and primary home owners who want to enter the housing market. Many of whom who had been wiped out from the Great Recession --- and along with it their credit score.
In a move the White House administration is advocating, the FHA is also suggesting banks to take "compensating factors" into consideration when underwriting loans. In addition, banks are also being encouraged to use more subjective judgment when it comes to approving a loan. Translation: Look at a borrower's overall savings and ability to make a larger down payment.
"My view is that there are lots of creditworthy borrowers that are below 720 or 700 -- all the way down the credit-score spectrum," according to Carol Galante, FHA Commissioner. "It's important you look at the totality of that borrower's ability to pay."