The Importance of Avoiding Disputes

Remember when our parents used to drill into us that we should make every effort to live at peace with everyone and stay out of conflict whenever we could?  Some parents, like mine, followed that basic message with a second message: if somebody attacked us first we needed to defend ourselves. But that second admonition was only to be used if all of our efforts to avoid conflict had failed.  For most of us the basic message was clear--stay out of trouble if you possibly can.

Today, Fannie Mae has taken on the role once held by our parents of reminding us that disputes are bad.  No, I am not talking about the fight with the school yard bully at recess, or the on-going conflict with the neighbor who refuses to clean up the weeds and trash in his yard.  I am talking about disputed items on a credit report, which due to Fannie Mae's new guidelines have turned into a real problem for borrowers looking for conventional financing.

A few years ago, disputing items on credit reports was all the rage.  I have had borrowers with mobile phone accounts that they insist they never opened, utility bills they claim they never signed for, apartment leases that their ex-boyfriend/girlfriend was supposed to pay, etc.  Most people with collections on their credit report are fairly insistent that those accounts do not belong to them.  And in some cases, that is true.  We live in an age where identity theft is a huge business--from online hackers with spyware looking to steal account numbers and passwords to waitresses and waiters who are able to make copies of credit cards at restaurants, this society is filled with people who are benefiting financially from destroying another person's credit.  In some cases, the problem does not stem from something as sophisticated as formal identity theft but the account being billed does deserve to be disputed because it was double billed or previously paid, or the service or product being billed for was never supplied. 

Filing a dispute has been a fairly easy process since the three major credit bureaus became more accessible through their websites.  A consumer disputing a tradeline needs only to go to the website of the credit agency in question, order a copy of his own credit report, and then click the dispute tab to have the bureau investigate it.

While the dispute process has many legitimate uses, we also recognize that, as with many good things in this world, the process has been exploited and abused by credit repair companies who dispute all of the derogatory items on the credit report so that the creditors will have to respond to the credit reporting agencies' request for information.  The creditor is supposed to respond within 30 days, and if he fails to respond the agency is supposed to remove the item in question.  Of course, this is a very short-term fix because when the creditor does respond, the offending item goes right back on the credit report, but it has been used to artificially elevate credit scores very briefly so that borrowers who really do have very bad scores can temporarily raise their scores enough to get a loan.

Scams like these must have been what prompted Fannie Mae to make its new rule about disputed items.  A borrower with a disputed item on a Fannie Mae credit report must now have the dispute removed before the loan can close or else the credit score cannot be considered in underwriting. 

I had read about this a couple of months ago, but I was confronted with it this week as I was getting files ready to refinance.  One borrower in particular has basically good scores, extremely high income, low debt in relation to his amazingly high income, and a lot of assets.  He also has a few collection accounts which he refuses to pay.  I wanted to make sure that he would not be required to pay these accounts at closing (I have done quite a bit of work for his family and I know that he would rather not refinance than pay collection accounts, so I wanted to find this out first), so I started by running his file through the automated underwriting system to make sure that he could leave the collections unpaid.  And then, as I stared in amazement at my findings, I remembered what I had read about the disputed accounts a couple of months ago.  My borrower does not have to pay his collections because they total less than $5000.00, but in spite of his wealth, basically good scores, and low debt, he cannot get approved for this refinance because he disputed two of the accounts, which combined total less than $500.00 unless he removes the dispute from each credit reporting agency.  Removing a dispute could take months, and he is only refinancing to take advantage of the low interest rates right now.

The item he is disputing is a charge from an insurance company that he insists he does not owe.  The account is a couple of years old and is insignificant when compared to the rest of his credit history.  But here is the most amazing part--even if my borrower decided that the new refinance was more important to him than this measly collection and paid the collection account in full, Fannie Mae still would not give him the loan!  Even if the bill has been paid, if the account is on the credit report showing that it is in dispute, the credit scores cannot be utilized.  And since accounts stay on a person's credit report for seven years from the date of last activity, this account will be there a long time.

Yesterday I talked about how strict new underwriting guidelines are making it nearly impossible for even good borrowers to qualify for mortgage loans, and this new underwriting rule about disputes is another example.  I have no doubt that this rule was implemented to weed out weak borrowers who artificially inflate their credit scores by disputing items on their reports.  But, in an effort to sift out these borrowers, Fannie Mae is also punishing borrowers with long credit histories and scores that are reflective of how they have managed their credit over time but who have had a legitimate disagreement with a creditor.  The result is that borrowers like mine who are a good credit risk, have the income and assets to pay, and have a long, mostly clean credit history, get their loans denied.

In checking around, I learned that Freddie Mac does not have this same rule, so the file can be sent through their automated engine instead.  For my borrower, that means losing his interest rate lock since the lender I was going to use does not allow his specific loan product on Freddie Mac.  Fortunately, the rates are still low and we can salvage this deal.  But in a market with volatile rates, this would have cost him the opportunity to refinance and take his 15 year mortgage loan down to a 10 year while knocking nearly a point off his rate.

The morale of the story:  1.  Read the credit report carefully before you submit the file to see if there are any disputed accounts--even closed ones.  2. Remember Mom and Dad's words of wisdom and where ever possible, avoid disputes.

And the Good News Just Keeps on Coming...

On the heels of a dismal existing home sales report on Tuesday, Wednesday saw a dismal new home sales report. The National Association of Realtors is reporting that sales of new homes have hit a historic low of 276,000 for the month of July. That is the lowest number of recorded sales since record-keeping began in 1963. At the same time, housing prices have fallen to the lowest levels in 7 years--the median price for a single family home is now $204,000 which is the lowest since 2003.

This is bad news not only for real estate but for the construction industry as well, and it is also bad news for the job market as real estate and construction have been steady employers for the last 10 years or so. As new home sales continue to drop, we are going to see more builders closing their doors, which is going to lead to more bankruptcies and layoffs and general economic problems.

It also bad news for my industry. According to the NAR report, mortgage purchase applications are currently at the lowest levels in 13 years while mortgage interest rates are the lowest levels in 20 years. Eighty-two percent of mortgage applications are for refinances.

Of course these are national averages. In my city, El Paso, Texas, the local news is reporting that our sales of existing homes have actually dropped 44% between June and July as opposed to 27% which is the national average. That really is shocking because we have never had huge appreciation in our market and as a result we never had to deal with huge depreciation either. Our values were stable, and we counted on the influx of buyers from Mexico and the influx of troops from Fort Bliss, Texas to keep us afloat no matter what was going on nationally. So a 44% drop is astounding.

In response to all of this bad news, CNBC posted a story that the Fed is looking at resuming its program to purchase treasury notes in order to further drive down mortgage interest rates to spark some activity. (The Federal Reserve was holding rates down through March of 2010 with a program to purchase mortgage backed securities. When the Fed's intervention ended in March, all of us expected interest rates to rise, so the interest rate drop this summer was an unexpected gift.) But with 10 and 15 year fixed rates currently at 3.875% and below, I do not see how further lowering interest rates is going to do anything but help the same set of borrowers with great credit and income who have been refinancing for the past two years free up a little more cash.

Don't misunderstand--I am thrilled that the rates are low. It is exciting to see borrowers actually save hundreds of dollars per month and lower their already low interest rates by 1% or more. Last year when I was refinancing borrowers, I thought I had seen the lowest rates I ever would. But I do believe that there is a point when just continuing to lower interest rates is a wasted exercise. If borrowers are not going to buy houses when the thirty year rate is under 4.5%, will they be more motivated if the thirty year rate is under 3.5%? I don't think so.

I believe that the real problem is the inability of borrowers to qualify under the strict underwriting guidelines. Put simply, nobody likes rejection. Many people will really avoid situations where they feel embarrassed, and for many potential homebuyers, being denied for a loan is a potentially embarrassing situation. Borrowers do not want to apply for a loan there is a good chance they are not going to get.

On top of that, the paperwork is so huge and the requirements are so exacting that many borrowers lose patience during the process. Many people do not like signing hundreds of pages of forms they do not understand both during the application process and at closing. I received a closing package today that was 147 pages! There were so many documents that the attorneys who prepared it finally just sent an additional loan package to make sure that title had everything they needed. Borrowers are discouraged by high costs, delays, and stacks of paperwork, and they don't want to go through all of the headaches to be told, "I am sorry, but at the end we just could not get you into this home."

If we want to get the economy moving in the right direction again, we have to loosen up access to credit. If mortgage guidelines were relaxed, more borrowers would qualify, which would induce more borrowers to apply. As they purchased homes, the builders would start selling homes, the sellers who are waiting to sell their own homes before they can purchase new homes would now be able to buy homes, etc. Before long, builders and the real estate community might be able to actually hire some help, which would put Americans back to work. Those new hires would then have some money to spend at their local retailer, and before long he or she could hire some help,too. And then, those new hires would have some money to spend. But the entire process begins with access to credit.

I realize that the justification for making credit guidelines so tight is that we do not want the kinds of problems we saw two years ago in the credit markets. Lending money is by its very nature risky--there is always a possibility that for one reason or another the person you loan to will not pay you back. The only loan that is 100% risk free is the one that never gets made in the first place. So rather than rushing to buy treasury notes to drive rates down, why not try loosening up lending guidelines and circulating some money in the form of mortgage loans with reasonable interest rates. Since Fannie Mae and Freddie Mac are both controlled by the government, this would be easy to do and it might pay off for the whole country!