I like the blownmortgage.com blog and Chris today writes a post today on declining loan to value ratios. Chris, if this is your first post, and it indicates the qualify of your writing, I am looking forward to more.

The phrase “Declining markets,” are going to become more and more important. Banks are being burned by the lack of appreciation in Midwestern areas like Indiana, Ohio, and Michigan, and imploded areas like Nevada and Florida. Loans aren’t performing because people in trouble can’t sell their homes for anything close to what they owe. And no bank wants to be around when the music stops, so at some point–sooner than you think–we see 25% down payments required on all conventional loans.

Loan to value ratio, folks, is the percentage that a bank is willing to lend to you, out of the total value of your house. In simple terms, if your house is worth $100,000, and they are willing to go 80% LTV, that means they will lend you up to $80,000, because 80% of the $100,000 value is $80,000.

Just for perspective, these are the typical loan to value ratios in a "normal" market (what we had before the huge runup in credit and home prices starting around 2001):

Bad credit up to 65% LTV

Good credit, hard to verify income, self-employed, 75% LTV

Good credit, good income, good job history, 80% LTV

Good credit, good income, good job history, with private mortgage insurance 90% to maybe 95% LTV

Okay. Now lately, in the last 4 or 5 years, banks were throwing money at people who had horrific credit and unverified income at 95%, 100% or higher (!!) LTVs.

Let's continue with Chris's thoughts:

How it will unfold.

The presumption is that more problems are happening in the wholesale channel than the retail channel. This is probably true–how sane can it be to let 26 year olds control the financial future of millions of homeowners? To keep their exposure in an area low, the banks start by adding more stringent appraisal requirements. Usually, they request extra comparable sales by the appraiser comps), and the comps are within three to six months–in lieu of a year or so. The next slowdown is when a a lender makes an appraisal review mandatory for certain areas and loan programs. An appraisal review is essentially a second opinion, generally by an appraiser that makes absolutely certain the first appraiser’s work was valid. In practice it’s lower.

The appraisal rules may slow everything down, but they don’t stop lending. They do serve to weed out some of the inflated transactions and speculatory efforts that are part of Real Estate.

Chris, you are spot on with my experience especially in the real estate booms and busts earlier in California (not that I'm that old, but you know, older than many…)

What Chris is saying is that the problems are happening more with loans that mortgage brokers originated rather than loans that the banks originated themselves. The banks, when they lend themselves, are more careful. A mortgage broker just wants to get things through so they are more willing to exaggerate.

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Exaggeration comes often in the form of inflated appraisals. Appraisers are about to get a lot of blame, bigtime. Some will go to prison, I am sure. And there will be new legislation. Last time around, appraisal licensing was put into place. Fat lot of good that did. Fact is, the banks haven't been holding their own mortgages either. They were selling them off. Selling your loan off to some investor in the Middle East or Europe or Japan or China. So the banks are complicit — they have been pressuring appraisers to inflate the appraisal just to get a loan done.

Of course, what comes up also comes down. And the appraisals are going to get more strict and that is what Chris is suggesting will happen, or is happening.

Regional Loan To Value–will it be contained?

The next things that banks do is restrict loan to value (LTV) within a geographic region or city. This started with subprime lenders like the late Southstar, BNC, Decision One and Option One cutting values in states like mine. As they were in their death throes, they thought they could assuage Bond traders by cutting LTVs in “high risk states” It did not work. Nobody wanted to be the last one to hold those risky bonds, so they died anyway. The trend is coming to conforming lending, and the markets affected are going to wither.

Real estate used to be quite local. It is still quite local in some ways. But in other ways it is not. Credit is required for real estate prices to go up the way they have. Very easy credit. And that is an international phenom, not a local one. But still, the banks in a local area tend to have a lot of exposure to that local market. So they will adjust their lending policies, specifically the loan to values, according to the conditions in thier local area. So things will be different in different parts of the country.

For awhile.

Then they will catch up and be terrible everywhere, I am afraid.Thanks for reading http://www.mortgagereliefformula.com

Remember this: loan to value depends upon one number, the loan amount, which is easy to figure out. The other number, the value, is hard to figure out. It can come from an appraisal. It can come from a broker's price opinion (BPO). It can come from what you were willing to pay. But value is much harder to determine and in a market when lenders become scared, values will fall quite rapidly.

Loans that were available three months ago may not be anymore. And when the appraiser comes out, she will have been told to "be conservative" rather than "just get the appraisal through at $120,000".

That means you may not be able to get a new loan. And if you sell, your buyer may find his lender isn't willing to lend as much as he needs. Ugh.