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For better or for worse, California often gets first dibs on changes in the national real estate market and in what could be an example of the worst case side of that trend, some mortgage shoppers in the Golden State may be the first to be underwritten out of the home buying market. A data crunching company's new index, designed to help Californians choose less risky housing markets, says California lenders, fearing rising default risk levels, are already more closely scrutinizing mortgage applications.

That could make it tougher for already border-line borrowers to get financing or for existing home owners to tap their equity. During the last six months of 2005, risk levels for new mortgages statewide increased an average 28.6 percent in the Golden State, according to San Juan Capistrano-based HomeSmartReports.com, which for the first time offered such data to the public. The risk factor is lowest in coastal Southern California and the San Francisco Bay Area and highest in the rural Central Valley. The greatest increases came in the Salinas and Santa Cruz-Watsonville areas. The index trended down in rural areas north of Sacramento. The high risk areas typically are where more and more buyers stretched financially to get into a home. As home prices have soared beyond a half-million dollar median price statewide, many California home buyers suffering home price sticker-shock migrated away from coastal regions to the Central Valley where homes are cheaper. But the financial stretch makes them more vulnerable market conditions that could cause them to default on a home loan. "The frenzy we saw in more coastal markets last year moved inland at the same time as interest rates were edging up. Some neighborhood sales patterns are showing signs of market stress, and buyers may be stretching their finances. Lenders are evaluating loan applications and appraisals much more carefully," said Mike Ela, HomeSmartReports.com president.

Ela said the problem is exacerbated by home builders developing large plots of homes and offering easy-money, no- and very low-down payment financing to buyers stretching to become home owners. Home owners with no or small equity stakes in their homes are more likely to quit home ownership. "The moment things get tough, people walk away from homes and you are left with an excess supply of homes," Ela said. In addition to consumer and developers' habits in the expanding Central Valley market, lending trends in recent years has opened the doors of home ownership to many new categories of buyers who previously could not qualify for a home loan. Such a policy may soon become too much of a good thing. Even if it means putting a damper on the housing market, lenders have little choice but to curtail their risk. Jonathan Lansner a columnist with the Orange County Register said local lenders including New Century, Impac and Downey were experiencing smaller net interest margins -- the gap between a banker's cost of money and income from loans -- compared to the margins a year ago. Similarly, in October the Federal Reserve Board's "October 2005 Senior Loan Officer Opinion Survey on Bank Lending Practices", surveyed loan officers from 57 domestic banks nationwide and found that one-fourth of those surveyed said that they had narrowed spreads of mortgage rates over an appropriate market base rate (which means there are more loans with attractively competitive rates available) and that they had increased the maximum loan-to-value ratio on such loans (which means borrowers are allowed to carry even greater debt loads). Ela said lenders frequently reexamine underwriting policies as an ongoing prudent business practice to keep risk manageable, but federal pressure is likely adding to their concerns. "Lenders are great at managing their risk and I think that lenders are being more vigilant on their own, but I suppose to some extent if they view regulators as coming down the pike they are going to review any process that could be an influencing factor," increasing the level of risky loans, said Ela.

Federal financial regulators last year twice warned lenders to curtail risky mortgages, most recently in December when they issued a detailed "Interagency Guidance on Nontraditional Mortgage Products" to address the over abundance of risky purchase mortgages. The proposal was not unlike "Credit Risk Management Guidance For Home Equity Lending" released earlier last year to target risky equity loan making. Regulators want lenders to step back, scrutinize easy-money mortgages -- no and low-down loans, no-doc mortgages, interest only loans, piggy back loans, option-payment mortgages and the like -- and write fewer of them. That's because rising interest rates and flat and falling home values could leave home owners high and dry with mortgages larger than the value of their home. The HomeSmartReports index couldn't come at a better time. Ela said because this is the first time the report was released to the public there's no comparison data among the foreclosure trends, sales activity, resale pace, price appreciation, fraud and flipping activity, and other data used come up with the 1 to 100 index, based on a 1-low to 100-high scale. The increase is based on a proprietary benchmark the company established for an ongoing index. Right now the index numbers appear low, given the 1 to 100 spread. The highest index was only at 6.72 in the Hanford-Corcoran area; 6.08 in Bakersfield; 5.44 in Madera; 4.88 in Visalia-Porterville; and 4.48 in Merced.

Larger metropolitan areas have even smaller index numbers -- 0.80 in San Diego; 1.12 in San Francisco and 1.44 in both Los Angeles and San Jose (Silicon Valley). The concern lies in how much the numbers have risen since HomeSmartReports.com benchmarked the data. "In the end, what we want to do is educate consumers about value, risks and trends. Is an area solid or shaky? The strategy is to give them information to inform them so they can make good buying and selling information," Ela said. "We want to level the playing field," he added.

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