Conforming mortgage guidelines are the Home Loan Rule Book, delineating between applicants that approved for a mortgage and those that do not.Effective today, the rule book just got a little bit tougher.

According to Fannie Mae, homeowners converting their primary residence into a second home or investment property will be subject to additional underwriting scrutiny.  Fannie Mae is leery of lending to people that may be over-extended.

The complete underwriting update is available at the Fannie Mae Web site but some of the more important points are summarized below, divided into Second Home and Investment Property.

Second Home Guideline Changes

• Without 30 percent equity in the second home, mortgage applicants must have 6 months worth of PITI reserves for both properties in their bank accounts.
• With 30 percent equity, the PITI reserve can be reduced to 2 months.

Previously, there was no minimum reserve requirement.

Investment Property Guideline Changes

• With 30 percent equity in an investment property, 75% of the monthly rental income can be applied toward the applicant’s monthly household income.
• Without 30 percent equity, rental income may not be applied to the applicant’s monthly household income and 6 months PITI is required for both properties.

Previously, 75% of the rental income was allowable regardless of equity, and minimum reserve requirements were 2 months.

Even though just a small percentage of Americans own second homes or investment properties, the conforming mortgage guideline changes impacts homeowners everywhere.

This is because more restrictive guidelines lead to two separate, but concurrent, outcomes:

1. The demand for homes reduces because fewer buyers qualify for mortgages
2. The supply of homes increases because fewer sellers can refinance into more affordable home loan

Less demand and more supply places downward pressure on home prices.

Now, remember that mortgage guidelines continuously evolve and what’s accurate as August 1, 2008, may not be accurate six months down the road.  In other words, confirm what you’re reading about mortgages online with your loan officer before making any real estate-related decisions.

Monday, President Bush signed the Housing and Economic Recovery Act of 2008 into law and the press jumped on the obvious storylines:

• First-time home buyers get a $7,500 purchase “credit”
• Conforming loan limits move to $625,000
• Delinquent homeowners get a lifeline from the FHA
• Local governments get federal money for buying and restoring foreclosed homes

However, tucked away on the last few pages of the text, in a section called “Revenue Offsets”, there’s an important tax implication.  The new housing law changes the way in which capital gains exclusions are calculated on the sale of a residence.

Under the old system, a taxpayer was entitled up to $250,000/$500,000 of tax-free gains from the sale of a home if filing separately/jointly provided he lived in the residence for at least 2 of the preceding 5 calendar years.

Savvy homeowners exploited this verbiage, moving from home-to-home every 2 years to avoid paying capital gains.

The new law thwarts this tactic.

Capital gains exclusions are now calculated by taking the capital gains on the sale of the home and multiplying it by a ratio of how long a person has lived in a home, by how long that person owned the home.

In the example above, a person living in a home for 2 of 5 years would be entitled to 40 percent of tax-free gains on a home sale instead of all of it.  As always, however, it’s best to talk with a qualified accountant about how tax code changes may impact you personally.

The new capital gains rules go into effect starting January 1, 2009.

Sometimes, the hardest part about news is knowing where to find it.In its filing with the SEC last week, Freddie Mac stated that it will “pursue increases” to its middleman fee.  This would likely make mortgages more expensive for every conforming borrower in the country.

The exact verbiage from the filing is extremely opaque and unless a person knew what things like “delivery fees” were, or “bulk and flow transactions”, he’d be inclined to skip right over the offending passage, tucked away on Page 72 in a paragraph labeled Business Outlook.

But, if we paraphrase the passage and simplify it for laypersons, it reads something like the following:

We didn’t charge enough fees in 2007 to account for the massive number of defaults.  We don’t plan to make that mistake again in 2008.

Strangely, in the entire 1,394-page filing, this passage is the only mention of “future default costs” leading to more loan charges.  In other words, it’s easy to see why this story didn’t get picked up by the major news outlets.

To the media, the major angle in Freddie Mac’s filing was that it registered to sell $10 billion worth of securities.  For everyday Americans, though, the major story was a different one — mortgage fees may never be as low as they are today.

Therefore, if you know that you’ll need a new, conforming home loan soon — for either a home purchase or a refinance — consider moving up your timeframe.  Whether rates rise or fall, it’s likely you’ll pay a more money to borrow money only because you waited.

The implied fee increase would be the third this fiscal year, following increases in December 2007 and in April 2008.

For the first time in its history, the FHA changed its funding fees and mortgage insurance structure this week.  FHA-insured home loans are now subject to a risk-based pricing adjustment, as shown by the table above.

Because of risk-based pricing, FHA home loans are now more expensive for borrowers with less-than-ideal credit profiles, and less expensive borrowers with perfect ones.

Prior to the changes, most FHA borrowers paid an up-front fee of 1.500 percent, plus on-going annual mortgage insurance payments equal to one-half-percent on the amount borrowed.

FHA-insured mortgages have grown in popularity this year because, while the guidelines of other mortgage products have tightened, FHA program guidelines have remained loose.  FHA allows 3 percent downpayments on purchases, for example, and allows “cash out” refinances to 95 percent.

Fannie Mae and Freddie Mac do not.

(Image courtesy: FHA.gov)

It’s a terrific time to buy a home, but not because homes happen to be affordable.It’s a terrific time to buy because the variety of mortgage products available to home buyers looks poised to shrink.

Monday, Alt-A mortgage lender IndyMac Bank stopped accepting mortgage applications and it’s likely that other Alt-A lenders will likely follow suit.

Alt-A loans are ones in which borrowers can’t (or won’t) verify one of two major underwriting criteria:

• Evidence of income
• Evidence of assets

Since the Credit Crunch began last July, Alt-A mortgages have been a steady source of funds for ”in-between” borrowers — those that are not quite prime, and not quite sub-prime.  IndyMac was among the largest lenders of its type and had outlasted many of its peers.

Its position as a market leader and subsequent exit from lending means that the remaining Alt-A lenders will likely make one of two choices in the coming weeks:

1. Raise rates and fees because of greater Alt-A mortgage risk, or
2. Follow IndyMac’s lead and exit mortgage lending altogether

Both outcomes would be harsh for home buyers of all types because when any large bank takes mortgage-related losses like IndyMac just did, it tends to create major risk aversion in the market.

Risk aversion impacts everyone – even the “good” borrowers.

Banks have been nervous about lending for several months and so they’d rather pass on an “average” mortgage application rather than risk getting stuck with a potentially “bad” one.  IndyMac’s exit may cause fewer mortgages to get approved.

In other words, buyers eligible for financing today may be ineligible tomorrow.

Therefore, if you’re a home buyer and you know your credit profile is less-than-ideal, consider writing a purchase contract sooner rather than later.  Your mortgage options may be thinning, and the ones you have may be getting more expensive.

In the summer of 2005, sub-prime mortgage lending was at its peak.  Rates were relatively low and lending guidelines were relatively loose.

At the time, the “standard” sub-prime mortgage product was the 3/27 ARM.

The 3/27 had a few basic traits:

• A fixed, 3-year “starter rate”
• Every six months thereafter, the mortgage rate changed
• The formula by which it changed was (4.999 percent + the 6-month LIBOR rate)

If the loan was interest only, it usually converted to principal + interest at the first adjustment, too.

Because the summer of 2005 was the peak of sub-prime lending, it makes sense that the summer of 2008 is the peak of sub-prime adjusting.

For homeowners with adjusting sub-prime loans, there is some (relative) good news out there.

Today, the 6-month LIBOR hovers near 3.15 percent, meaning that an adjusted mortgage rate will be in the neighborhood of 8.15 percent.

This is versus the rate of 10.30 percent that sub-prime borrowers faced last summer when LIBOR was much higher than it is today.

Adjustments of any size can strain a household budget, though, so if you’re a sub-prime borrower and your pending adjustment will cause financial strife, be proactive — talk to your lender before you miss a payment.

Lenders are often more willing to talk with “current” borrowers than with delinquent ones.

(Image courtesy: Washington Post)

A Home Equity Line of Credit is bank product that grants homeowners access to the equity in their home at anytime, usually using checks.Often called a HELOC, these equity-based credit lines function very much like credit cards:

• The rate is adjustable, tied to Prime Rate
• There is a minimum monthly payment
• There is a pre-set spending/credit limit

But different from credit cards is that a HELOC is “guaranteed” by real estate and with real estate values in question nationwide, many banks are exercising a little-known clause in the HELOC contract.

With alarming frequently, banks are reducing the pre-set spending limits on their active equity lines.  Via USPS, lenders are notifying homeowner with $100,000 HELOCs that their new HELOC limit is $25,000, for example.

And the banks aren’t being discriminate based on payment history or local real estate conditions, either — it’s happening everywhere with equal force.

The good news is that banks will accept appeals on HELOC reductions on a case-by-case basis.

One way to appeal a HELOC reduction is:

1. Call your lender’s Customer Service line.  Do not send an email.
2. Politely ask why the HELOC limit was reduced.  Listen carefully to explanation.
3. Explain why you would like your HELOC reinstated.  Acceptable reasons may include home improvement projects or improper home valuation by the lender.
4. Be prepared to write a formal letter, if asked.  Address the issues explained in #2.

Banks will typically not reinstate a HELOC if a borrower has been delinquent on payments, or lives in a severely depressed neighborhood.  However, because lenders rely on computer models to assess risk, it’s always a good idea to ask.

Sometimes the Human Element of an appeal can work in your favor.

Mortgage approvals don’t last forever.A conforming mortgage approval from Fannie Mae or Freddie Mac has a shelf-life of 120 days.

After 120 days, the approval expires and a mortgage applicant must re-submit his application for consideration.

In addition, a mortgage approval can “expire” within the 120-day period for other reasons:

• Change of job status or income
• Newly-acquired monthly debt (i.e. car payment, student loan)
• Change in asset levels

If your current mortgage approval (or pre-approval) is dated prior to February 3, 2008, it is now expired and your new approval may be subject to Fannie Mae’s new, more strict, underwriting guidelines.

Mortgage financier Fannie Mae is toughening its mortgage application decision-making process effective Monday, June 2, 2008.The new guidelines will force many Americans to face higher mortgage rates, higher loan fees, or to be shut out from “prime” mortgage rates altogether.

The new “mortgage rules” include the following changes:

1. Higher income levels required for basic approvals
2. Interest only loans are now considered high-risk
3. Condos are now considered high-risk
4. 60-day mortgage lates within 6 months are a major red flag

Not all of the changes are for the worse, though.

In the new guidelines, self-employed borrowers will no longer be viewed as more risky than a W-2 employee.  This will help small business owners and commission salespeople get more mortgage approvals than in the past.

Fannie Mae agreed to honor all mortgage approvals granted prior to its changes, so if you’ve been putting off that pre-approval, consider talking to your loan officer before the weekend starts.

Your mortgage approval will be much more lenient today than if you wait until Monday.

It’s not often that a mainstream media publication taunts renters into buying homes, but that’s exactly what Smart Money does in its latest issue.

The Smart Money Web site “lead-in” reads 5 (Lame) Excuses for Not Buying a Home.  That’s a forceful title!

It’s unfortunate that renters could feel antagonized by the author’s tone because the article raises very good counter-points to the more popular reasons why renters avoid homeownership.

Owning a home is a serious responsibility and does require commitment.  However, a renter should not feel bullied or hurried into buying because for as much as personal economics are at play, personal emotions are at play, too.  Both deserve respect.

So, renters: Put your blinders on and give the Smart Money article a read.  There’s good advice in there once you get past the author’s bias.