Down economies and home loans

Down economies affect home loans in various ways, many of which are unwelcome to most of the population. But why does it seem that these two items are always related? With this question in mind, there are many changes to expect regarding home loans in the remainder of 2009.

First, you should understand the "why" and "how" of down economies and recessions. The simple answer: "What goes up must inevitably come down." Recessions typically follow a strong and growing economy. In free (or, more likely semi-free) economies, the business community competes and succeeds (or fails) on its own merit, offering products and services that consumers want to buy.

Oddly, the more successful the economy, the greater the potential for a deeper down economy or recession. Compare an economy to nature for a moment. Often, an extended period of sunny and dry weather is followed by a consistent period of rain and unsettled conditions.

Most nations' economies historically enjoy or suffer the same fate. Look also at the U.S. stock market for further confirmation. As all experts know, a period of growth and stock price increases will eventually experience a "correction," which is a polite way of describing a major drop in prices and value.

Down economies typically affect the real estate and home loan market the same way. In prosperous economies, home values typically increase, sometimes rapidly. As the population has more income from this "hot" economy, they purchase more homes, creating an equally booming home loan industry. During these periods, loan interest rates are usually reasonable, sometimes very low.

Enter the down economy when home fair market values (FMV) are high. FMVs can drop quickly as the economy first affects the business community with lower revenues, unsold products, and expenses outstripping income. Layoffs and downsizing are necessary to balance declining income and constant expenses.

Soon, people have less income – sometimes, no longer even having jobs. They cannot purchase new homes. As buyers disappear, home values decrease as sellers give up their former paper profit and reduce prices to entice the few buyers in the market.

Home loan delinquencies and foreclosures increase, often putting even more properties on an already overloaded market. As Economics 101 tells us, as the supply of something increases when demand decreases, prices must come down – often way down. The repayment of home loans becomes an ever larger problem.

Typically, the home loan and real estate value problems exist until very near the end of the down economy.

Some specific home loan changes to expect

A rather unusual condition in the current down economy is that the real estate and home loan industries are identified as a major cause – not just an effect – of the sorry economy. During most of the new millennium, the housing market has been booming, with some buyers and record-setting low interest rates. Unfortunately, some lenders offered "exotic" – e.g., risky – adjustable rate mortgages (ARMs).

Even before the economy crashed, some homeowners had trouble affording these ARMs as their interest rates increased beyond the borrower's ability to make payments. Here are some of the unfortunate and unwelcome home loan changes to expect in 2009 and, possibly, beyond.

A return to classic home loan lending methods

For some people, and the mortgage lending industry in particular, this is the "good" news. The stability of the home loan industry has historically depended on sound lending policies. Proven debt-to-income ratios have helped lenders and borrowers get the home loans that they could manage. The loose rules of the past five years are no longer available.

Some home loan products may no longer exist

As often happens in a reactionary period, many loan products have disappeared from the marketplace. Unfortunately, some creative, yet sound home loans have also been removed, causing undue hardship on some otherwise qualified borrowers, like self-employed people and commission employees. In most cases, you may see only basic "vanilla" loan products being offered in the near future.

Higher credit scores may be required

Credit scores required to get many types of home loans may be increased dramatically. For example, if a 620 credit score formally allowed you to be approved for a typical home loan, lenders may increase their minimum credit scores to 700 or above.

When combined with the disappearance of many other home loan products, this change in qualification rules can potentially eliminate thousands of people from the homeownership equation.

Most sub-prime home loans may be unavailable

Except for the Federal Housing Administration (FHA) mortgages, most non-conforming and sub-prime home loans may now be unavailable. While it is true that most of the home loans that caused the massive problem in the mortgage industry were from the "sub-prime" and non-conforming categories, the elimination of most of this category of home loan products will inflict damage on the many borrowers that could have managed reasonably constructed mortgage loans.

What to do about the changes

Obviously, these expected changes in home loans are not pleasant for prospective homeowners, but, unfortunately, the mortgage industry is in the midst of some drastic chnanges that are leading to more conservative lending measures.

There is little that most people can do but try to keep their credit score as high as possible, learn the classic mortgage qualification rules, and conserve as much cash as possible, since the availability of a large portion of financing is over for the immediate future.

See also: Home loan FAQs