Why are loans so much harder to get with interest rates at their lowest levels in decades?

Key Points

  • This economic crisis caused by the pandemic has driven interest rates to rock bottom levels.
  • Banks have tightened standards, becoming more choosy about their borrowers and asking a lot of questions.

As public school teachers, Tori Smith and her husband have careers that should survive the coronavirus economy, but their mortgage lender wasn’t taking any chances.

It told them that they would have to put down more money to keep the interest rate they wanted, then dialed back what it was willing to lend them. And Ms. Smith said it had checked their employment status several times during the approval process — and again a few days before the couple closed on their home in Zebulon, N.C., last month.

Ms. Smith said she had never gotten a straight answer about the new requirements, but she ventured a guess. “I felt like we had to bring more just because of Covid,” she said.

The economic crisis caused by the pandemic has driven interest rates to rock-bottom levels, meaning there has hardly been a better time to borrow. But with tens of millions of people out of work and coronavirus infections surging in many parts of the country, qualifying for a loan — from mortgages to auto loans — has become more trying, even for well-positioned borrowers.

Lenders that have set aside billion of dollars for future defaults have also tightened their standards, often requiring higher credit scores, heftier down payments and more documentation. Some, such as Wells Fargo and Chase, have temporarily eliminated home equity lines of credit, while Wells Fargo also stopped cash-out refinancing.

It’s not unusual for lenders to tighten the credit reins during a downturn, but the current situation has made it especially challenging for them to get an accurate read on consumers’ financial health. Borrowers have been able to pause mortgages, halt student loan payments and delay paying their tax bills, while millions of households have received an extra $600 weekly in unemployment benefits. Those forms of government support could be masking an underlying condition.

“It makes it hard for a lender to understand what the consumer’s true state of credit quality is and their ability to pay back a loan,” said Peter Maynard, senior vice president of global data and analytics at the Equifax credit bureau.

Credit card companies, for example, mailed out 57 million offers to consumers in June, a historic low and down from 272 million a year earlier, according to Mintel, a research firm that has been tracking the offers since 1999. Some banks have stopped offering the types of cards that attract people who may be focused on paying down debt, such as BankAmericard, Mintel found.

Issuers are also being careful with cards belonging to current customers, said Mark Miller, associate director of insights for payments at Mintel.

“Some dormant accounts are being closed,” he said. “So if they have a credit card sitting in a drawer, those accounts are at risk of being closed, and credit lines with a $10,000 limit may eventually be knocked down to $8,000.”

For auto loans, borrowers with lower credit scores and thin credit histories face more rigorous requirements and less generous terms, including shorter loan periods.

“Subprime borrowers are not getting loans as readily as they were pre-pandemic or a year ago,” said Jonathan Smoke, chief economist at Cox Automotive, referring to consumers with credit scores below 620.

Interest rates for new and used vehicles remain low — below 4 percent at many banks and credit unions — but only for more qualified borrowers, said Greg McBride, chief financial analyst at BankRate.com.

“Good credit and a down payment are required to get the best rates, with weaker credit increasingly sidelined — particularly for older-model used car purchases,” he said.

Ford Motor said it hadn’t tightened standards on loans through its financing unit, but last month it introduced a program to make wary borrowers more comfortable. Those who buy or lease a car through Ford’s financing unit before Sept. 30 can return it within a year if they lose their jobs. Ford said it would reduce the customer’s balance by the vehicle’s book value, and then waive up to an additional $15,000.

If that measure is meant to stoke demand, no such program is necessary for home buyers.

For the first time in nearly half a century of tracking, 30-year fixed-rate mortgages averaged about 2.98 percent, according to Freddie Mac. The mortgage industry made $865 billion in loans during the second quarter, the highest amount since 2003, when quarterly originations twice topped $1 trillion, according to Inside Mortgage Finance, a trade publication.

And that’s with lenders being picky about their customers and particular about their requirements. JPMorgan Chase, for example, will make mortgages to new customers only with credit scores of 700 or more (up from 640) and down payments of 20 percent or higher. USAA has temporarily stopped writing jumbo loans, which are mortgages that are generally too large to be backed by the federal government, among other products. Bank of America said it had also tightened its underwriting, but declined to provide details.

Ms. Smith and her husband, Philip Ellis, had hoped to go through a first-time homebuyer program at Wells Fargo that would require them to put down 3 percent. They even sat through a required educational course. But two weeks before closing on their $205,000 home, their lending officer said they needed to put down 5 percent to keep their rate.

A week later, Ms. Smith said, they learned their loan was for less than what they had been preapproved for — and they needed to come up with an additional $4,000. In the end, their down payment and closing costs exceeded $14,000 — about 45 percent more than they had anticipated.

The couple, who had married in April, used money recovered from their canceled wedding reception. Ms. Smith said they were also lucky to have the support of their families, who fed and sheltered them so they could save every penny. But the stability of their jobs was also most likely a crucial factor.

“I think our ability to secure the loan was due to us both being schoolteachers and having a contract for employment already for the following year,” she said.

Wells Fargo said it hadn’t increased its credit score requirements, but it has raised down-payment minimums on certain loans not backed by the government because it had to suspend most interior appraisals of homes during the pandemic. Even under normal circumstances, there are a variety of situations in which borrowers may be asked to raise their down payment or obtain a better rate by doing so, a company spokesman said.

Some lenders also want to know more about borrowers’ other possible sources of cash.

When Chris Eberle, a technology executive, and his wife were locking in their jumbo mortgage for a new home in Palo Alto, Calif., their lender, a California mortgage bank, wanted to know not only how much they had in their retirement accounts but how easy it was to get at that money.

“They wanted, account by account, details on the withdrawal and loan options,” Mr. Eberle said.

And they, too, had to put down more than they had planned. Before the crisis, a jumbo loan could be had with 10 percent down. Mr. Eberle said they had to put down 20 percent — and found a cheaper house to make it easier.

Other borrowers, including the self-employed, are being asked to provide more detailed proof of their earnings — at least when they’re getting a loan that will be backed by Fannie Mae or Freddie Mac.

“Employment and income verification for self-employed borrowers is now multiple times more detailed as it previously was,” said Ted Rood, a loan officer in St. Louis who lends nationally.

Income verification is also more rigorous across the board, and Mr. Rood said he was required to do two verifications over the phone. It makes sense, he said: He had just prepared a loan for a married couple — a gym owner whose income had suffered and his wife, a speech therapist with a seemingly more stable position because she was able to work with clients remotely.

“We were set to close on a Monday in early June,” said Mr. Rood, who was working at Bayshore Mortgage Funding, which is based in Timonium, Md., at the time. But when the loan processor called the wife’s employer the Friday before, the processor learned that the woman had been laid off.

The lender withdrew the loan.

This article originally published by Tara Siegel Bernard. New York Times.

In a Nutshell

Lenders are very sensitive to future defaults and as noted in this article, they’ve set aside large reserves of cash to offset any losses caused by future defaults. But of course, the goal of any lender is not to lose principle and ultimately, their interest income. So tightening up lending policies help ensure this doesn’t happen. Lenders are scrutinizing borrowers and it takes more than strong income to qualify for loans; strong creditworthiness is the result of more than stable income.

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