Potential homebuyers hit mortgage brick wall (© Ghislain & Marie David de Lossy/Getty Images)

© Ghislain & Marie David de Lossy/Getty Images

Banks are awash with money. But you can't get a mortgage loan. How crazy is that?

If you've been rejected for a loan, you're in good company. Lenders are rebuffing nearly a third of the people who apply for money to buy a home, the Mortgage Bankers Association says. It's worse if you're refinancing: Nearly half of all applicants are turned away.

We talked with experts about what's behind the mortgage drought and how long it's likely to last. If you hope to buy or sell a home or refinance into historically low mortgage rates, it's a good idea to understand the market.

The drought in homeowner credit is bad, says Matthew Kover, manager of the mortgage-loan division at Port Orchard, Wash.-based Kitsap Bank, with 20 branches in communities west of Seattle.

"I turn away solidly 50% of the loans I originate," he says. That means that of all the applications he tries to get through the approval process, only half become loans. It doesn't include all the would-be borrowers he sends home to polish their credit scores and beef up their applications.

After the circus
At first, Kover says, he welcomed a return to conservative lending principles after seeing prudent requirements practically tossed out the window in the mortgage bubble. But he says the restrictions have gone too far.

"I'm continually making excuses to customers for regulations that really don't have any justification," he says.

Banks and the federal government have tightened lending requirements. Each blames the other for the difficulties consumers have getting financing. It's all a reaction to the big mortgage circus a few years back, when government regulators were lax, banks were handing out easy money and borrowers racked up debts they couldn't pay.

The riskiest loans, made from 2004 to 2007, still haunt banks: The federal government now owns many of them and is forcing banks to buy some back.

Home affordability calculator

The effects reverberate on Main Street. Government supervisors have lenders under a microscope.

"People with FICO scores under 700, which is still good credit, are getting cut from the market because the government is being so tough on the banks over mortgages that went bad. And the banks are like, 'I'm not going to loan to these people anymore,'" says Paul Miller, mortgage analyst with FBR Capital Markets & Co.

Banks don't have to follow those strict government requirements. But Fannie Mae and Freddie Mac buy 56% of all mortgages in the U.S., which means banks can keep the fees and billing work yet use the money again to make more mortgages. So they abide by government rules.

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Although they're complaining about burdensome government requirements, lenders are piling on their own restrictive requirements for borrowers, called "overlays." If government rules make it difficult for borrowers, bank overlays can make it nearly impossible, Kover says.

For example, the government's minimum FICO score for mortgage insured by the Federal Housing Administration is 500, with 10% down. With a credit score of 580, you can be eligible for a mortgage with as little as 3.5% down. That's just the starting place, not a guarantee you'll get a loan.

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In reality, many lenders won't consider applications with scores below 640. The average FHA borrower today has a 700, according to the Mortgage Bankers Association.

That keeps would-be homeowners such as Jydia Scott, 34, and her husband, Sammie, 33, on the housing-market sidelines. The Scotts and their four children have lived with relatives in Riverdale, Ill., south of Chicago, for three years. They can't quite qualify for a loan, says their agent, Dona Crane of Keller Williams Preferred Realty.

Jydia Scott, who's watched prices fall from $120,000 to $40,000 or $50,000, has her eye on the perfect $54,000, four-bedroom fixer-upper. She could buy it with $1,000 down, she says. "We would love to be able to jump in and take advantage of it."

Their paychecks would support the payments, but the hang-up is their credit scores: His is 590, hers is 563.

"They told us we needed to be at least at a 620, and they could work with us," she says.

Piling on rules
Kover, of Kitsap Bank, combs through large lenders' offerings to find the best features and prices for his customers. These days, it's difficult, even for borrowers with 700 FICO scores. "An individual can still qualify for a loan with a score below 700, but the rates are usurious," he says.

The requirements for a "conventional" loan, the kind with the lowest interest rates and strictest government guidelines, are even higher. The minimum FICO score is 620, but in practice, 755 is the average borrower's score, a Freddie Mac spokesman says. In 2001, it was 718.

Your credit score is only one piece of your loan application. The entire package — your debt, your history of managing credit, your income, your credit score and the property itself — has to qualify. The cheapest loans go to squeaky-clean borrowers. With previous credit problems, even if you do qualify, you'll have fewer choices and pay a higher rate.

Lenders also are tightening rules for down payments. Kover says that it has been his experience that one major lender, for example, has stopped lending to anyone with a credit score below 740 — a respectable number — without a 20% down payment.

"Any number of mortgage-insurance providers are willing to underwrite and insure a 5% down-payment loan with credit scores below 740. But (that lender) says, 'No,'" Kover says.

James Barth, senior finance fellow at The Milken Institute and an expert on U.S. mortgage markets, says, "Banks are saying, 'Why should we lend the way we did a few years ago? It got us into trouble.' They're unsure about where the housing markets are headed. So they just lend to the less-risky borrower, and they're going to require higher down payments."