For most people, the home buying process can be intimidating as well as exciting. This is likely the largest financial investment of the homebuyer’s life. The current buyer’s market and low interest rates, not to mention recent tax incentives, are encouraging buyers to take the plunge. Nevertheless after years of easy financing during the real estate boom, banks are now reluctant to lend, frustrating would-be homebuyers. According to Agence France Presse, Federal Reserve chairman Ben Bernanke recently stated during a speech in Chicago, that, despite bailouts, “bank lending continues to contract and terms and conditions remain tight.”
What’s behind the current difficulty in getting a loan? Many things, according to experts; some are obvious, others are not. For example, anyone who has applied for a mortgage recently knows that the relaxed standards of a few years ago are gone. Fico scores, LTV’s, proof of funds – any requirement that did not necessarily matter for qualification before, matters now – very much. It seems a natural reaction on the part of the lending institutions. If easy qualifications have gotten you into trouble, you reverse course, dramatically. Today, only very qualified buyers need apply.
However, this is the obvious answer. With all the bailout money banks received, it’s easy to wonder why they are not in turn pumping it into the economy. After all, they are in the business of lending and the health of the economy was a major rationale for programs like TARP. Still bailout money came with few requirements from the federal government for the banks that received it, so they are not obligated to make any certain number of loans.
In a NY Daily News article last year, James Wilcox, a business professor at the University of California at Berkley, attempted to explain the banks’ perspective. When a bank makes a mortgage loan, the home is the collateral asset. The loan-to-value (LTV) ratio represents the level of risk the lender is taking. With many LTV’s significantly above 80% and defaults rising while prices fall, “Lenders”, said Wilcox, “have been shell-shocked by the extent of their loses. Now they want more cushion against these loses.”
The struggling economy is another major factor in banks’ reluctance to make loans. Wilcox is quoted as saying, “It’s not an unusual pattern that when the economy weakens, lending standards get tighter.” With unemployment hovering around 10%, banks may be looking for a rosier economic picture to emerge, especially if they already have bad loans on their books.
The economic crisis has badly shaken both the banks’ confidence and their finances. AFP reports that, during his speech in Chicago, Ben Bernanke warned, “The number of regional and community institutions considered weak is still increasing, and their loan loses will likely remain elevated this year.” According to The Associated Press, Fannie Mae is currently seeking $8.4 billion in federal aid and posted a first-quarter 2010 lose of over $13 billion. Taxpayers have spent $145 billion on bailouts for Fannie Mae and Freddie Mac and together, they own or guarantee close to 31 million home loans worth over $5 trillion. With Freddie Mac and Fannie Mae in their own economic turmoil, the all-important secondary market for mortgages is far less robust, threatening lending’s entire present business model. Secondary market demand is a huge incentive for banks to make loans, because it takes the lose risk off their books and places it with the secondary market, usually investors or taxpayers.
Economically, lending is a lagging indicator. Mortgage and small business lending are not likely to pick up until the recovery is well established, so don’t expect the vanguard of the boom to lead us out of the bust. It’s often said that banks like to lend money to people who don’t need it. Due to the lending excesses of the recent past, most people, businesses, and even banks, are all in need right now.
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