Some mortgage lenders have begun tightening standards on some popular loans

[DamianDunlap]

By RUTH SIMON and JAMES R. HAGERTY
Staff Reporters of THE WALL STREET JOURNAL
September 29, 2025


Getting Tougher


Some mortgage lenders have begun tightening standards on some popular loans that have helped fuel the housing boom in recent years.

• Washington Mutual has told brokers it plans to make it more difficult for borrowers to qualify for its option ARMs.

• Countrywide Financial is raising the bar for borrowers who want the lowest teaser rate for option ARMs.

• New Century Financial plans to limit interest-only loans to below 25% of total loans, from 33% in the year's first half.






After years of easy money, some mortgage lenders are beginning to tighten their standards.



Lenders have rolled out a raft of new mortgage products in recent years that have made housing purchases more affordable and allowed many people to extract cash from their homes' equity without boosting their monthly payments.



Now, in what could be the first signs of a reversal, some lenders are starting to raise the bar on making these products available to new borrowers. To be sure, rates for many types of mortgages have been rising anyway as the Federal Reserve has boosted short-term interest rates. But some mortgage lenders are going further by making it harder for borrowers to qualify for certain loans. Other lenders also are cutting back on the number of riskier mortgages they make or raising rates.



Last week, Washington Mutual Inc., one of the nation's biggest mortgage lenders, told mortgage brokers that it will make it more difficult for borrowers to qualify for its option ARMs, which carry an introductory rate of as low as 1.25%. Under the new rules, which are expected to take effect next month, borrowers will have to show they can afford the monthly payment if the interest rate on the loan is 6% -- or 6.25% for borrowers purchasing a second-home or investment property -- after the introductory rate expires. Currently, the bank's rate for qualifying borrowers for these loans is roughly 5.25%.



New Century Financial Corp., a mortgage lender in Irvine, Calif., last week said it was aiming to reduce the amount of interest-only loans it grants to less than 25% of total loan production from 33% in the year's first half. New Century said it was making the move in an effort to boost profit margins.



Some lenders are making their loans more costly, which could discourage borrowing. This month, Option One Mortgage, a unit of H&R Block Inc., boosted the rates on all of its mortgage products by 0.40 percentage point. Option One says the move reflects both rising interest rates and changes in investor appetite for its loans.



The moves come as bank regulators are sounding the alarm bells about rising risks in the mortgage market. Federal Reserve Chairman Alan Greenspan said in a speech this week that "the apparent froth in housing markets may have spilled over into mortgage markets" and called the "dramatic increase" in interest-only mortgages and "more exotic forms of adjustable-rate mortgages ... developments that bear close scrutiny."



The chairman's remarks echo the concerns of other bank regulators who fear that some borrowers are using exotic mortgage products to purchase houses they couldn't otherwise afford. If the housing market stalls, regulators are concerned that defaults could climb.



For consumers, tighter lending standards and higher costs could make it harder to afford homes and ultimately could help cool some hot housing markets. "It will take a lot of people out of the market and take some of the speculative fervor out of the market," says Kenneth Rosen, chairman of the Fisher Center for Real Estate at the University of California at Berkeley.



The tightening in mortgage lending is not yet widespread and some mortgage brokers say they haven't yet seen any indications that banks have pulled back. But the recent changes are particularly noteworthy because they follow a long trend of loosening that was apparent as recently as this summer.



Among other changes, Countrywide Financial Corp., another big lender, earlier this month made it tougher for borrowers to qualify for a 1% teaser rate on its option ARMs. Countrywide now considers a number of factors in setting the introductory rate, including the size of the loan, how much documentation the borrower provides, and whether the property is a second home or for investment. The teaser rate for borrowers with multiple risk factors can be as high as 3%, the company says.



Other lenders are also boosting their charges. Golden West Financial Corp. says that next month it will raise the introductory rate for its option ARMs to 2.20% from 1.95%. The rise "will be the first of several moves," says Golden West Chairman and CEO Herbert Sandler. "I don't know how high it will go, but it should go higher," he adds.



Raising the teaser rate on an option ARM boosts the minimum payment a borrower must make, particularly in the loan's early years. The teaser rate is used to determine the minimum payment in the first year; after that there's a cap in the first few years on how much the minimum payment can increase, unless the loan balance climbs beyond a certain threshold.



The tighter lending standards also come as profit margins on some loans are being squeezed. Credit rating agencies have tightened their standards for certain mortgages, and investors who buy pools of mortgages are beginning to demand higher yields for purchasing riskier loans.



Other changes may be less noticeable to borrowers, at least initially. Several lenders that offer option ARMs have raised the "margin" used to determine the interest rate on the loan once the introductory-rate period ends. To set the rate on the loan, lenders each month typically add the margin to an index that measures short-term interest rates. Since the index rises along with market rates, the banks' wider margins represent additional costs to new borrowers beyond increases in short-term interest rates.



In mid-August, Washington Mutual increased the margin on its option ARMs by 0.20 percentage point to 2.5%. As a result, a borrower who took out an option ARM tied to one popular index -- the 12-month Moving Treasury Average -- might pay 5.52% instead of 5.32%. Also last month, Countrywide boosted the margin on its option ARMs by between 0.125 and 0.375 percentage point, depending on how risky the loans are. Downey Financial Corp. and Secured Bankers Mortgage Co., California-based lenders, also raised the margins on some option ARMs, company executives said.



Because the introductory rate on an option ARM is so low, the minimum payment generally isn't enough to cover even the interest that is due in the loan's early years. That means borrowers who choose to pay the minimum amount can make regular payments and still see their loan balance swell, also known as "negative amortization." Borrowers could also be hit with sharply higher monthly payments down the road when the monthly payment is reset so that the loan can be repaid over a 30-year period.



Even before the recent changes, rising short-term interest rates were making products such as option ARMs less attractive. A borrower with an option ARM tied to the Moving Treasury Average that currently carries a rate of 5.52%, after the introductory rate expired, would have paid about 4% in June 2004, according to HSH Associates in Pompton Plains, N.J. Rates on loans tied to other popular indexes can be well above 6%, HSH says. That compares with a current average of 5.97% for a 30-year fixed-rate mortgage.



At the same time, some lenders are pushing more borrowers who take out option ARMs into loans that carry prepayment penalties. In a conference call with investors in July, Countrywide said that nearly three-quarters of its option ARMs carried prepayment penalties, up from 18% in 2003. GreenPoint Mortgage, a unit of North Fork Bancorp, recently modified its option ARM program to make loans without prepayment penalties less attractive. More than half of the option ARMs GreenPoint grants now carry prepayment penalties, up from less than one-third a year ago.

[MrMAD2]

WAMU (Washington Mutual), Countrywide, and New Century are three national residential lenders who typically only loan on what are known as "conforming" deals. These are "A paper" (great credit, full documentation, income verification) loans. The typical programs the majority of the public hear about are these types of loans. What the typical consumer doesn't know is that many of the same programs exist for non-conformin customers; however, not through the majority of large national lenders such as these. IF these lenders will even give a person with poor or damaged credit, the self employed person with poor tax reports, etc. a loan, they will restrict their options to less than favorable programs which benefit the lender the most.

There ARE however plenty of programs available to the less than stellar borrower, AND they are still available now.

With regard to interest only and ARM programs, this is something of a conflict that is fueled mostly by the lending industry of the large lenders and the media representation which of course fuels the American Mob (most of us at home watching the t.v. and being swayed by marketing and the media). Most typical homeowners don't bother to entertain options available to them because the idea of a 30 year fixed mortgage or interest only has been so deeply pushed into the mindset of most of us. Just like most are also aware of what an FHA loan is and want it, but truth is that for the vast majority of people, these options are not in their best interest.

Years ago, most of our parents and grandparents never even entertained the thought of selling their house and moving at some point down the road. Today's families though often wonder how long their current house will suit their needs or how long they'll be staying at their current job, etc. If you were to ask yourself, "Will I definitely keep this house for 30 years or longer and never need to refinance it for any reason?" and can not answer "Yes!" to both parts, then a 30 year fixed mortgage is probably not in your best interest. If your annual debt to income (DTI) ratio is greater than 35% debt (35% or more of the money you make goes back out for verifiable bills and debt) and/or you don't have the greatest credit (and despite what most people think, a 600 credit score is NOT great credit), then most conforming lenders will shut you out of fixed rate and interest only programs. Not only that, but 95% to 115% lending programs will also not likely be available to you, so in addition to owing more money than the "great" borrowers (from a lender's view point) do, you also now need to come up with more money down for a purchase or get less money out on a refinance to pay off debts, etc.

Truth is, there are tons of options available through companies that are not conforming lenders that give you most of the same options as national conforming lending leaders, if at only a small increase to stellar rates. Adjustable rates (ARMs) are also a great thing to keep your rate lower, especially if you feel that it's likely that in a few years you may either move or want/need to refinance your home. Keeping an open mind and getting the information through the blockade of hype that most of us put up without even realizing it is a good thing.

For those of you that don't know, I am a mortgage professional. I have worked with all three of the lenders that were discussed. I no longer personally work with residential clients, although my company is a direct lender for residential loans. I now work solely with commercial property mortgages. Should anyone want additional information, though, feel free to PM me with a contact email and your questions, and I'll try to answer them as quickly as I can.

[DamianDunlap]

Good post man. Pick a door one thru 4. When the revamp is done. Your door will go up

[MrMAD2]

3 has always been a magical number...