On the heels of this summer’s subprime mortgage crisis and reports in the media of a nationwide credit crunch, it is easy to understand why consumers are hesitant when it comes to borrowing. They are asking themselves, “Is it safe?” “Is money available?” “Will I get approved?”
If you are credit-worthy, the answer to all of these questions is “Yes!” At many banks, there never was a credit crunch. In fact, as headlines reported tightened lending trends in the financial pages of national newspapers and Internet sites, The Washington Trust Co.’s mortgage activity reached its highest levels in two years, commercial lending remains strong, and we were the leading SBA lender in dollar volume for the fiscal year ended September 2007. What’s more, right now may be a good time to buy, especially if you are in the market for real estate. Prices, interest rates and inventory are all working in your favor.
Still, the events of last summer served as a wake-up call on the perils of borrowing without performing the proper due diligence. Understanding what was behind the headlines will help consumers make better decisions about borrowing in the future, and also give them the confidence to do so.
A financial perfect storm
The subprime mortgage crisis was fueled by low interest rates and the perception among lenders and borrowers that property values would continue to rise. Add to the mix overzealous brokers and uninformed buyers, and there were nothing but dark clouds on the horizon.
The storm arrived when real estate values began to decline and interest rates went up. Already saddled with significant debt, borrowers watched their adjustable-rate mortgages (ARMs) kick into a higher rate, increasing their monthly payment on properties that, in some cases, had lost value.
The subprime mortgage crisis gave ARMs a bad name, but the fact is ARMs can be a good financing solution for specific borrowers and situations. Both fixed-rate and adjustable-rate mortgages can be excellent choices. The role of the lender is to help borrowers determine which financing tools make the most sense for them – and when an option puts them at too much risk.
When I ask customers why they are turning to us for financing today, more often than not they tell me that they know they can trust us. The irony is, the very things that some customers saw as negatives with bank financing a couple of years ago – strict underwriting standards, income verification, lots of due diligence – are now being embraced as measures that protect them.
Fringe event goes mainstream
The problems in the mortgage industry occurred on the fringes. Borrowers were approved with no documentation, stated income and low credit scores. In many cases, loans were written at 100 percent loan to value, and borrowers sometimes needed well more than 50 percent of their income to cover their monthly payments. Is it any wonder that people got into trouble? Unfortunately, many of these borrowers probably shouldn’t have received a loan in the first place.
Banking is a highly regulated industry; some parts of the mortgage business are not. At a bank, you have to do things by the book – and that protects both the lender and the borrower. The numbers bear this out. The delinquency rate on subprime loans is 20 percent; for traditional loans, the national average is 5 percent. However, last summer, the public did not make this distinction between fringe and mainstream lenders. The subprime collapse made for great headlines, creating the perception that the problem was pervasive. The reality is, there was plenty of liquidity at established financial institutions for credit-worthy customers – and that remains true to this day.
Five tips for smart borrowing
Banks have money to lend and a willingness to lend it. Consumers looking to borrow will be well served by following these fundamental guidelines:
• Find a lender you can trust.
In light of the subprime mortgage crisis, it’s critical to turn to an established, reputable lender who will look out for your best interests and stand by the loan. Find a lender who is interested in establishing a relationship with you, not merely completing a transaction.
• Know your limits.
Be careful not to overextend yourself. Your lender should be able to help you determine what level of borrowing is appropriate based on your financial situation. Do not base your decisions on risky assumptions, i.e. market conditions you cannot control.
• Shop for rates – but don’t stop there.
Be a smart consumer when it comes to rates. By all means, shop around for the best terms you can find, but consider the source. If something looks too good to be true, it probably is. Remember, reputation is as important as rate.
• Consider your options.
Ask your lender to present all available alternatives so you can evaluate which solution works best for you. No single loan is right for everyone. And before discussing any financing options, your lender should understand your objectives and financial situation. Only then can someone truly make a recommendation that is right for you.
• Read the fine print.
Make sure you know what you are buying. Are there prepayment penalties? Do the terms of the loan change over time? Know the details before you sign. •
John C. Warren is chairman and CEO of The Washington Trust Co. Founded in 1800, Washington Trust is Rhode Island’s largest independent bank.
