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Banks Overlays Have Economic Impact

Knowing your lender can help you get a better rate in today's market.

One of the most frustrating things for consumers to deal with is the inconsistency in lending rules. For some banks, lending guidelines promulgated by Fannie Mae, Freddie Mac or governmental loan programs are sufficient to protect them from the risks of default by borrowers.  In other cases, banks add additional requirements called “overlays.” 

Overylays are a permitted and, in some cases, prudent risk-avoidance technique that banks use to ensure they do not have to “buy back” a loan sold in the secondary market.  The more strict a bank is in their lending requirements, the lower the risk of accepting a particular loan.   

For example, in the case of a governmental program, the U.S. Department of Housing and Urban Development, or other agency, might  issue lending guidelines indicating which types of loans, and under what parameters they will insure the loan against the risk of default. If a bank is lending its own—or its’ depositors’—money, it is able to closely follow those regulations.  

However, if a bank is using a warehouse line of credit to fund a loan, it must follow the rules of the bank promising to buy that loan. What this means to the consumer is that different banks impose different rules for the same loan program. This can lead to confusion and frustration for a borrower trying to finance a home.  

Furthermore, realtors often find that lending sources may not be consistent either.

As real estate professionals, many develop relationships with lenders whom they trust to provide excellent service, loan options and rates for their buyer clients. Our own local market has felt the effects of this dichotomy.  One family is able to buy a new home while the exact same buyer may not be able to qualify depending on the bank overlays in place.  

In the long run, stricter rules will have the effect of lowering the foreclosed home (known as the Real Estate Owned, or REO market) inventory.  This will result in the ability for home prices to begin rising again.  However, in the short term, such practices have the effect of limiting buyers’ ability to obtain financing.  

In that case, home prices remain deflated. Lower prices might seem to be a good impetus for buyers to get into the market. It often has the reverse psychological effect. Many continue to wait for “the bottom.”  Unfortunately, once the media begins to report that the market is moving again, usually, the bottom came and went.

A lack of movement on the real estate market leads to an inability of homeowners to be able to refinance current mortgages due to collateral values.  Lower home values keep more local residents upside down on their houses.   

In many cases, as the median salaries decline and joblessness remains high, more and more foreclosures become imminent.  Hence, we find ourselves in a vicious cycle of deflation of home prices and values, combined with extreme inflation of consumer goods and the total cost of living.  As prices for gas, food and any consumable good which is transported are passed along in higher prices for those goods.  Such inflation will demand higher interest rates in order to hedge against an over-heating of inflation.

So, as economic forces converge on our local citizens, one thing we can all do is to do our research.  If you are trying to obtain a loan, make sure that you are asking to now in advance if a lender has very strict overlays.  

Better yet, make sure to protect your credit scores.  While this is only one part of the lending decision, it is a vital one and has a definite impact upon one’s ability to borrow.  The more borrowing power one has (not to necessarily use it), the more housing values may begin to increase again.  More investment on real estate could lead to less investment in oil and oil futures.  This would have a positive impact upon the price of fuel, and thus other consumer goods.

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