By Peter Miller
The 1,000-page mortgage application is here, but don’t be alarmed: It’s a paper tiger, a low barrier to financing, and no more frightening than a marshmallow.
At first it may seem amazing that a loan application could be larger than a Tom Clancy novel, but it’s true. In fact, in today’s marketplace, 1,000 pages might well be regarded as a mid-sized file, a financial appetizer, and hardly noticeable in an era where 2,000-page applications are increasingly common. Indeed, a study by VirPack, a document management company, found that more than half of all loan applications now contain more than 500 pages while 20% included a forest-busting 1,000 to 2,000 pages.
So are heavyweight mortgage applications a big deal, enough to sink any effort to finance or refinance a home?
The answer is no. Paperwork demands by lenders are about as scary as butterflies. The problem is largely that no one explains why so much documentation is needed, how big page numbers are totaled, and why this is a lender problem and not a big deal for borrowers.
Lenders, Borrowers, and the FHA
Lenders and borrowers have been around for a long time. As an example, Deuteronomy says debts should be forgiven after seven years while Leviticus advises that debts should also be forgiven in jubilee periods, celebrations which occur every 50 years.
Mortgage lending in the U.S. as we know it today really began with the establishment of the Federal Housing Administration — the FHA — in the 1930s. The great innovation of the FHA was not lower rates but longer mortgage lengths. Instead of the typical “term” loan that was common at the time — a loan that lasted just five years — the FHA popularized the use of self-amortizing mortgages that lasted 20 years.
If you got an FHA-backed loan it meant you didn’t have to refinance every five years. That was important because in five years you might be unemployed, or the value of your property may have dropped so your term loan could not be refinanced. With a self-amortizing, long-term mortgage, once you got the loan you never had to go back and re-qualify with the lender as long as you made the monthly payments. Moreover, at the end of the loan there was no more debt because both the interest and the principal had been fully repaid.
While the FHA program was and is surely an attractive option for borrowers — today one in five loans is backed by the program — the FHA is not a lender. Instead, it’s an insurance program. You can buy with less money down if you finance with an FHA-insured loan. Of course, since the FHA is an insurance program, you also pay monthly premiums.
Back in 1929 there were more than 25,000 banks and probably more than 25,000 ways to process loans. Today there are fewer than 6,700 FDIC insured institutions, but loan applications are now pretty much all alike, because most loans are sold by lenders to such organizations as the FHA, Veteran’s Administration, Fannie Mae, and Freddie Mac. What’s not standard is how the information is used — a loan declined by one lender might be entirely acceptable to another.
All of this gets us to the subject of paperwork and the sea of pulp upon which the mortgage industry now floats.
The No Doc Loan
The mortgage underwriting system worked very well until the early 2000s. The foreclosure rate in 2000 was just below 0.4 percent, according to statistics from RealtyTrac.
But then foreclosure levels shot up, in large measure because of the sudden and widespread marketing of “non-traditional” mortgage products such as option ARMs, interest-only mortgages, and loans with little paperwork — so-called “low doc” and “no doc” loan applications. Indeed there were even such things as NINJA mortgages (no-income-no-job-or-assets) and NINA financing (no-income-no-assets).
The result of the new financial products and standards was entirely predictable: The housing market collapsed and foreclosure levels soared to heights unseen since the 1920s. As I told the Association of Real Estate License Law Officials — the folks who regulate real estate brokers at the state level — in a 2006 speech and at the height of the real estate market boom, “looming in the background is the potential for financial disaster that will impact home values nationwide, spur foreclosure rates to new highs and devalue insurance funds, pension holdings and investor accounts. The value of your home, no matter how you financed, is at stake.”
Wall Street Reform
New Wall Street regulations were passed in the aftermath of the foreclosure meltdown. The Dodd-Frank legislation signed by President Obama in 2010 was largely devoted to the issue of risk. No longer would mortgage lenders be able to originate residential loans that could plunge entire states into depression.
Central to Dodd-Frank — and central to today’s paperwork demands — are two important ideas.
First, Dodd-Frank includes an “ability to repay” requirement. Under this standard, lenders must verify at the time of application that residential borrowers have the ability to repay the loan.
The result is that lenders want to make certain that loan files contain enough data and information to unquestionably meet the verification requirement. Hearsay doesn’t count; everything must be in writing, and maybe more than once. Lenders want every document they can find to protect themselves against possible future claims that they failed to adequately verify the borrower’s ability to repay a loan.
Why are lenders so fanatical about paperwork?
“If it can be shown that they did not adequately verify borrower information, lenders can be forced to buy back the loan from investors, a huge cost,” said Rick Sharga, executive vice president for Auction.com. “Under the new Dodd-Frank rules, a borrower may also be able to sue the lender for making a loan that didn’t meet the ability-to-repay criteria at the time the loan was originated.”
Second, the Wall Street reforms included a “duty of care” standard. It requires that lenders must be licensed or registered and — here’s the big point — that the license or registration number must be on loan documents.
Why is the “duty of care” requirement important? By having license and registration numbers, mortgage investors can quickly determine who originated a given mortgage and then — in the same way that a lender can decline a loan application — an investor can say “no” to loans from a particular lender. In effect, a lender with a lousy foreclosure record, missing documents, or other problems may be unable to re-sell its loans to investors in the secondary market, and as a result will be forced out of business.
The result of Dodd-Frank is that foreclosure levels are now below historic norms. This means investors can make U.S. mortgage loans with little risk, and it’s the lack of risk that explains in large measure why mortgage interest rates are now so low.
Why Paperwork Claims Are Overstated
There’s no doubt that lenders collect a lot of paperwork, but so what? It’s not that they’re asking for 1,000 separate items. Instead, what’s happening is that they’re asking for complete documents, and those materials often have some heft.
As an example, in a recent mortgage application the lender got an appraisal for the property. The appraisal ran 27 pages. Then — to make sure the appraisal was right — the lender got an automated 22-page “value report.”
So here you have 49 pages of material and nothing was required of the borrower.
Here’s another example: The real estate sales agreement for the same transaction ran 18 pages. You sign here and initial there but it’s paperwork prepared by a broker or attorney.
Think about bank statements and retirement accounts. Lenders want the full statements, not just the first-page summary. And how about tax returns? Lenders want the entire return, not just the first two pages, for more complex returns.
All of this paperwork raises a question: Does anyone know what the stuff in a loan file actually says?
Not likely. Consider the testimony of two former secretaries of the Department of Housing and Urban Development, both lawyers.
Mel Martinez once explained to The Washington Post that “you know if I’m a lawyer and the secretary of HUD and I’m not reading this junk, you know there’s work to be done fixing the system.”
Alphonso Jackson, another former HUD secretary, told the Washington Times that “I’m an attorney and I’ve had eight houses and I didn’t read all that mess. If I didn’t read it — and I doubt anyone around this table read it — then we can’t hold people responsible for not reading every line when they were closing their loan.”
How to Handle Paperwork
Regardless of how nutty lender demands might be, the reality is that as a borrower you have an obligation to provide needed paperwork. No paperwork, no loan, so the lender has leverage. Moreover, if you drop one lender over paperwork the next one may be even more demanding.
There are, however, certain steps you can take to make the paper chase easier:
- Collect obvious documents before applying for a loan. Think of tax returns from the past two or three years, recent pay stubs, bank and retirement accounts, etc.
- Get stuff to the lender when asked. It makes sense to get a scanner, copy documents, and send them via email to the lender as PDFs. This way you have a record of what was sent and when. Moreover, if a document is lost, it’s easy to re-send.
- Don’t be surprised if a lender keeps asking for paperwork. One lender was absolutely insistent on seeing a homeowner’s association insurance policy for common areas. Okay, no big problem. All it took was a call to the HOA secretary to produce the 63-page document, a good example of why mortgage application files are so thick.
- Remarkably, don’t be surprised if a lender asks for paperwork AFTER closing. One of the many forms signed at settlement says you’ll help the lender if there are any missing signatures or documents.
- If you look carefully at the closing documents, you may see multiple copies of the same form which you must sign. This happens because various players in the closing process all want a copy of the form with an original signature. It’s a good example of lots of paperwork but not a lot of borrower effort. Sign ’em all and make lenders happy.
- Make sure the loan application and closing materials include the disclosures and facts that are important to you. For instance, if you’re refinancing an investment property make certain the documents specifically show that you’re getting an investment loan and not residential financing. Why? Applying for a lower-cost residential loan to finance or refinance an investment property could land you in hot water.
- Don’t let lenders, brokers, and closing providers talk you into signing documents or taking steps that make you uncomfortable. As an example, what if you’re a seller and the settlement provider says that payment might be delayed a few days? In my state, the government explains that “the practice of requiring a borrower to sign closing documents and actually delay funding the loan is not permitted.” Be in touch with the settlement provider well before closing to assure that there are no surprises. If you’re not comfortable with something, consult with an experienced real estate attorney.
- Make every effort to be accurate and open, especially with negative items. The lender will find them anyway, so be able to explain what happened and why. With new standards, wait times for financing after a “significant derogatory event” such as a short sale or foreclosure have been shortened, especially for those with “extenuating circumstances” such as a temporary job loss, an illness, or a death in the family.
For all the moaning about mortgage paperwork, it’s not a big deal. While the pages do add up, for the most part it’s the lender’s problem and surely nothing that can’t be handled. After all, millions of mortgages are successfully originated every year, something that wouldn’t happen if the paperwork load was too overwhelming.
Peter G. Miller is a nationally-syndicated real estate columnist. His books, published originally by Harper & Row, sold more than 300,000 copies. He blogs at OurBroker.com and contributes to such leading sites as RealtyTrac.com, the Huffington Post and Auction.com. Peter has also spoken before such groups as the National Association of Realtors and the Association of Real Estate License Law Officials.