Your Mortgage : Rules for Low-Income Borrowers Relaxed

New changes to mortgage underwriting rules being distributed to lenders nationwide this fall could open the door to homeownership for thousands of renters whose credit, neighborhood, employment or even cultural characteristics often lead to rejected loan applications.

The revisions direct local mortgage companies to take off their middle-class blinders when they evaluate applications for low-down payment loans from lower-income buyers. Rather than turning away applicants who don’t fit the cookie-cutter mold of what homeowners “should” be like, the new guidelines ask lenders to take a deeper look, beyond the surface stereotypes.

For example, should a lender accept two married couples with a total of four dependent children, plus one single adult, as joint co-borrowers on a $145,000 townhouse with three bedrooms, one bathroom and just 988 square feet of interior living space? Do nine people in such a cramped space constitute a stable home-owning group?

Kurt Arehart, vice president for affordable housing of General Electric Mortgage Insurance Co., says this is precisely the sort of question his firm’s new underwriting guidelines are designed to address. At first glance, according to Arehart, five co-borrowers in one home would draw an immediate “no” from underwriters unfamiliar with cultures other than middle-class, white American.

“A lot of (lenders) apply their own cultural biases (to applications),” he says. “They can’t picture five adults and four children in that house because they can’t picture living that way there themselves under any circumstances.”

But GE’s research and statistical data from insuring $1.7 billion worth of loans to low-income home buyers--often ethnic or racial minority group members--suggest that such preconceptions by underwriters frequently are wrong. Absent any major negative factors, such as poor credit histories by individual co-borrowers, the number of people living in a property has no statistical connection with subsequent delinquencies or foreclosures, according to GE’s data. By itself, the presence of five co-borrowers should not be an automatic reason for rejection of the loan.

The same is true for a host of other “turn-down” factors that underwriters commonly use, such as periodic job changes by borrowers, non-traditional sources of down-payment cash and property locations in “declining” sections of the city.

GE’s new guidelines are the result of a massive evaluation of borrower performance under the “community home buyers” program over the past three years. The program has funded low down payment (5% down is typical) loans for more than 17,000 low-income purchasers, primarily in urban neighborhoods around the country. GE provided private mortgage insurance on loans originated by local lenders, who then sold the insured notes to Fannie Mae, the Federal National Mortgage Assn.

Mortgage insurance protects the mortgage investor from loss in the event of foreclosure. An insurer like GE, in other words, is highly motivated to identify risk factors in advance of approving any loan. Some of the key conclusions of the evaluation are cemented into the firm’s new underwriting standards for lenders. Among the most notable:

--GE has experienced no higher loss ratios on its low-income mortgage program than on its middle- and upper-income loans. That may surprise some mortgage market experts, but it’s fact. Low income “describes the amount of money people have,” says the firm in its underwriting manual. “It does not describe the risk they represent.” Low-income borrowers “usually buy houses to obtain a secure shelter to raise their families. They are not likely to seek homeownership for status or as a short-term investment--factors that may increase default risk.”

--Underwriters evaluating low-income loan applications need to show “sensitivity” and “creativity” in assessing such culturally variable factors as source of down-payment cash. For example, rather than automatically rejecting applicants whose down payments come in part from informal, community-based revolving pools of shared funds--like West Indian “su-su” accounts or “chit funds” popular among other immigrant groups--GE gives underwriters detailed guidelines on how to qualify borrowers using such pools.

--Lack of a credit history should not automatically disqualify a low-income borrower. Some cultural groups and recent immigrants “live in a cash society,” says GE, but are otherwise excellent financial risks. They “are not users of the conventional credit system,” with American Express cards, charge accounts at retail shops or car payments.

To evaluate such borrowers, the guidelines urge loan officers to search for other indicators of bill-paying ability. Tops on the list: Rental payments. If an applicant can document regular, on-time rent payments, that’s a big plus. On the other hand, if a cash-oriented applicant doesn’t pay the landlord on time, that’s a sure sign of thin ice.

--Splotchy credit, with periodic late payments on charge accounts stretching back several years, generally is a major negative factor. But GE’s data suggests loan officers should give the “greatest weight” to a borrower’s performance during the past 12 months.

Personal bankruptcy on the part of a borrower several years back, followed by a good credit history ever since, may be acceptable. But there’s one stain on a borrower’s record that GE absolutely won’t tolerate, cultural sensitivity notwithstanding: A prior foreclosure.

If you ever want a low-down payment insured mortgage--whether you’re high-income or low, middle class or patrician--stay away from foreclosure. That’s because the insurers who make the loan possible are the ones who get stuck holding the bag.