10 tips on mortgages for 2010

Will the loan market stay tight? Will bankers remain skeptical? What will happen to interest rates? Read on for answers to those questions and more.

More than three years into a painful housing crash, the real-estate market has sent recent — albeit tentative — signs of stabilization. Home sales have increased, inventory levels are down, and price declines have become less precipitous.

Along with more-affordable home prices and a tax perk from Uncle Sam, attractive mortgage rates — which remained near 5% as of late December — have been a driving force behind this development. The availability of low mortgage rates will play a decisive role in the performance of the 2010 housing market as well.

To help consumers better understand the requirements and costs they will face as they shop for a home loan next year, U.S. News spoke with a handful of housing market experts and compiled a list of 10 things to know about getting a mortgage in 2010.

1. Lending standards

The steep run-up in home prices during the first half of the decade was fueled in large part by breezy lending standards. Some bankers handed out loans without down payments or documentation requirements.

But when the housing bubble popped and those loans became massive losses, banks began raising lending standards for borrowers of all stripes. And with the labor market continuing to erode — the unemployment rate topped 10% in October — and mortgage delinquency rates setting records, there is no reason to expect credit requirements to loosen in 2010.

“Lending standards have tightened dramatically between 2007 and 2009,” says Scott Stern, the CEO of Lenders One, a cooperative of independent mortgage bankers. “I think there will be a little more belt-tightening in 2010.”

2. Down payments

This tight credit environment affects consumers in several ways. First, down payment requirements will be higher than they were just a few years ago. Loans backed by the Federal Housing Administration are at the low end of the spectrum and come with minimum down payments of 3.5%. (More on FHA loans below.)

Down payments on loans outside the FHA will vary depending on the market, the borrower and the property type.

“Generally, to get the best rate around, you need at least 20% for a down payment,” says Guy Cecala, the publisher of Inside Mortgage Finance, an industry newsletter. “That doesn’t mean you can’t get a mortgage if you have less of a down payment. . . . It just means that you are not going to get the best interest rates.”

Could lenders ease up on down payment requirements in 2010? Possibly. If lenders become convinced that home prices are improving, they may allow borrowers to put slightly less down. But don’t expect that to occur until the end of the year — if at all.

3. Credit scores

Cecala says borrowers will need FICO credit scores of at least 730 to get the best mortgage rates. They also will need to fully document their income and assets. To ensure that their credit scores are as strong as possible, borrowers should check their credit reports and watch for errors. The Fair and Accurate Credit Transactions Actentitles consumers to one free credit report from each of the three major credit reporting bureaus — TransUnion, Equifax and Experian — each year. The free reports can be obtained at AnnualCreditReport.com.

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“(Consumers) ought to know what their credit score is; they ought to know what’s on their credit report; they ought to make sure that what’s on their credit report is in fact theirs,” says Rick Allen, the director of strategic initiatives for Mortgage Marvel, an online mortgage shopping Web site. “That’s a must-do for everybody.”

4. FHA-backed mortgages

Borrowers who can’t meet these tighter lending requirements can turn to the FHA, which insures mortgage loans against default.

Standards for FHA loans are typically less onerous than those for private lenders. The average credit score for FHA borrowers is about 690, Cecala says. “If you can’t make the 730 (credit score) or you can’t make the 20% down, the next best thing is FHA,” he says.

The downside is that FHA loans come with additional costs. Borrowers must pay an insurance premium as well as a slightly higher interest rate, Cecala says.

5. FHA requirements

With so many borrowers unable to meet today’s stricter lending requirements, FHA-backed loans have become increasingly popular. Today, the FHA guarantees nearly 30% of new home mortgages. That’s a stunning increase from 2006, when the agency backed roughly 3% of new home loans.

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Meanwhile, the agency’s finances have deteriorated considerably. The seasonally adjusted delinquency rate for FHA loans increased from about 13% in the third quarter of last year to 14.36% in this year’s third quarter. At the same time, the agency’s capital reserve ratio dipped below the level that Congress mandates.

In the face of mounting political pressure, the Obama administration has announced steps that may make it more difficult for some borrowers to obtain mortgages backed by the agency. These include raising the minimum FICO score, increasing upfront cash requirements and possibly charging higher insurance premiums.

“We want to ensure that we are able to continue to support the housing market in the short term and provide access to homeownership over the long-term, while minimizing the risk to the American taxpayer,” Housing and Urban Development Secretary Shaun Donovan said in written testimony to a congressional committee.

6. Mortgage rates

Mortgage rates in 2010 are expected to climb from 2009′s extremely low levels. After the Federal Reserve announced plans to purchase debt and mortgage-backed securities from Fannie Mae and Freddie Mac last year, rates on 30-year fixed conforming mortgages fell to historic lows, plunging to 4.97% in late November from 6.19% a year earlier.

But the Fed’s asset purchase program is scheduled to expire at the end of the first quarter of 2010, and a lack of private demand for mortgage-backed securities could lead to higher rates.

Keep in mind that the Fed has already extended this program once. And if it appears that the market needs additional government support to keep rates low, the Fed could always decide to remain in the market. Keith Gumbinger of HSH.com expects rates to increase from current levels to between 5% and 5.25% by the end of March.

7. Jumbo mortgages

Rates on bigger home loans, called jumbo mortgages, have dropped to extremely attractive levels, dipping under 6% in November and near that mark now. “That ranks with all-time bests,” Gumbinger says.

But while he expects rates on jumbo mortgages to remain historically attractive throughout 2010, many borrowers won’t be able to obtain them. That’s because most banks have to keep jumbo mortgages on their books and therefore apply much stricter lending standards to them. (Smaller conforming loans can be sold off to Fannie and Freddie.)

“Your down payment requirements (for jumbo mortgages) are anywhere between 40% down to 20% down, depending upon what is happening in your marketplace,” Gumbinger says. “You may have to show superhuman strength in terms of credit; you may have to show extraordinary income size.”

8. Fed rate hike

In attempting to jump-start the economy, the Fed has slashed its benchmark federal funds rate to nearly zero. And even as some express concerns about future inflation, the central bank in early November said that economic conditions were “likely to warrant exceptionally low levels of the federal funds rate for an extended period.”

Economists don’t expect the Fed to raise rates anytime soon. “The statement does not lead us to change our view that the Fed will keep rates unchanged until the September 2010 meeting, when we expect the first rate hike,” Dean Maki, the head of Barclays Capital research, said in a report. But while an increased federal funds rate could push rates on certain products — such as adjustable rate mortgages or home equity lines of credit — higher, it has little direct influence on fixed mortgage rates.

9. Economic recovery

A recovery in the U.S. economy may also lead to increased mortgage costs. That’s because economic improvement could create more demand for credit, which pushes rates higher.

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At the same time, a recovery could embolden investors to move money out of ultrasafe assets such as 10-year Treasurys and into riskier investments. And because 30-year fixed mortgage rates tend to track the yield on the 10-year Treasury note, such a development would put upward pressure on mortgage rates.

Gumbinger says that economic improvement and other factors could push rates on 30-year fixed mortgages as high as 5.75% by midsummer. “After that, you are going to be at the whims of the economy,” he says.

10. Future of Fannie and Freddie

A wild card in the outlook for mortgage rates is the administration’s plans for Fannie Mae and Freddie Mac. The two mortgage finance giants — which buy home loans from banks — are a key source of liquidity for the market. The government-chartered companies have long been controversial, and speculation about their future has been mounting since their shaky finances forced Uncle Sam to take them over last year.

The administration’s plans for their future, which could include liquidation or converting them to public utilities, could become clearer in early 2010. This decision could have profound implications for mortgage rates, Gumbinger says.

“We could have some dislocations in the supply chains with mortgages depending upon how immediate or how gradual the changes to the structures of those companies are,” he says.

This article was reported by Luke Mullins for U.S. News & World Report.