Has the mortgage industry, in following stricter lending regulations, locked millions of consumers out of the housing marketplace?
A study recently released by the Urban Institute estimates that an additional 6.3 million loans could have been originated if only lenders could have returned to the underwriting standards used in 2001.
But is that the answer? Are there not other, safer steps the industry can take to enlarge the pool of potential borrowers?
The answer, of course, is complicated.
The New Borrower
One of the most profound problems faced by the lending community is that today’s borrower is likely to be very different from those who applied for financing in 2001. According to the U.S. Census Bureau, real median household income was $60,466 in 2001. This is the adjusted figure in 2017 dollars. The same household, using the same measure, earned $61,372 in 2017.
Not a lot of real growth. Meanwhile, the debt situation changed drastically.
There are four major areas of consumer debt: auto loan, credit card, student loan and mortgage financing. According to the Federal Reserve Bank of New York, each debt category has seen significant shifts between the first quarter of 2004 – the earliest quarter available – and the fourth quarter of 2018.
Americans love their cars and they’re willing to pay big money for them. In total, consumers had $720 billion in auto debt in 2004, versus $1.27 trillion at the end of 2018. That’s an increase of $550 billion.
Credit Card Debt
Americans buy a lot of stuff – very often, without the cash to pay for it. Credit card debt in the same sample period increased from $690 billion to $870 billion, a $180 billion bump.
Student loans have increased dramatically, rising from $260 billion in 2004 to $1.46 trillion in 2018 – an increase of $1.2 trillion.
The expense of an advanced education has become so exorbitant that many students can barely eat. This is not an exaggeration.
According to The New York Times, a study by Temple University’s Hope Center for College, Community and Justice found that “45% of student respondents from over 100 institutions said they had been food insecure in the past 30 days.”
The situation with mortgages is that borrowers owed $6.17 trillion in 2004, a sum that rose to $9.99 trillion in the third quarter of 2008.
By the end of 2018, household debt had fallen back to $9.54 trillion. Housing debt between 2004 and 2018 rose by $3.37 trillion. Housing debt between the 2008 peak and the end of 2018 fell by $450 billion, despite substantial price increases.
The New Reality
Unfortunately, wages have largely been frozen while debt levels have significantly increased.
No less important, other forms of debt are typically in place long before potential borrowers start looking at real estate.
Suppose a young adult graduates high school and decides to further his or her education. It makes sense, because a good degree can mean a lifetime of higher earnings.
The end of high school is also the time when people might purchase their first car. In addition, people often have expenses when they’re just starting out, and credit card balances can increase.
The result is that before anyone considers the purchase of a home, they likely have substantial financial obligations. This early-onset debt load produces three problems: First, early debt can push DTI levels well above allowable maximums. Second, more accounts and bigger debts can reduce credit scores. Also, each new account represents another opportunity for late or missed payments. Third, debt payments reduce the funds available for saving. That makes it harder to pull together the money needed for a down payment.
What Can Be Done?
According to the Mortgage Bankers Association, mortgage originations totaled $1.64 trillion in 2018 and are expected to reach almost the same level this year at $1.63 trillion. That’s a lot of activity.
The real question is whether lenders can get financing to qualified borrowers who may now be slipping through the application system.
The good news is that foreclosures have become rarer in today’s market and credit scores are up. The public is getting better at dealing with debt.
According to ATTOM Data Solutions, foreclosure activity is at a 13-year low. It turns out that, even with increased debt levels, borrowers are doing well.
Fair Isaac reports average credit scores reached 704 last year, a record.
And with the introduction of new credit scoring approaches this year, we may see even better scores ahead. With borrower permission, these programs track bank account usage, allowing lenders to better understand how applicants handle cash and credit.
Still, there are many responsible borrowers out there that lenders simply are not reaching. What follows are three ways they can do it.
First, let’s focus more on the Federal Housing Administration (FHA), Veterans Affairs and U.S. Department of Agriculture loan programs. In Fiscal Year 2018, HUD says that the “FHA insured more than one million mortgages for single-family homes and nearly 83% of FHA purchase mortgages served first-time homebuyers.”
There were 383,115 purchase mortgages guaranteed by the VA in Fiscal Year 2018. Of this number, 159,714, or 42%, went to first-time borrowers. With the USDA loan program, 85% of all purchase mortgages went to first-timers.
These government programs are available with little or nothing down, and include a variety of sensible underwriting provisions. Their DTI requirements, credit standards and approach to first-time borrowers have been successful for decades.
With these federal programs, the industry has in place the mortgage tools needed to help some of the 6.3 million borrowers identified in the Urban Institute’s study.
Lenders need to inform more qualified borrowers about programs with federal backing because they’re available, well-established, require little money up-front and are often the best option for first-time purchasers.
If borrowers don’t qualify for an FHA, VA or USDA loan, non-Qualified Mortgage (non-QM) products are a way to help those who don’t fit within the tight confines required for QM. To be successful in this niche market, retail lenders need to understand how non-QM financing works and the steps necessary to avoid excess risk.
And for borrowers who are big earners but who may not have W-2 income, or who have more complex credit profiles, manual underwriting may also be needed.
Lenders need to keep automated underwriting in perspective. Automated underwriting is great. It’s speedy and saves money, but at this point it’s not always enough. Lenders want to know their borrowers. It’s a way to reduce risk. If there are credit issues, they want to know more.
For example, are they seeing borrowers irresponsibility – or was a fundamentally-sound applicant undermined by events no one could control? Was a job downsized or outsourced? Did a business suddenly shut down? Was there a medical emergency? What is the applicant doing to recover?
Maybe the pro forma credit information the industry is seeing reflects just a short-term issue with an otherwise credible applicant – someone a lender might want to finance.
Having a Great Story
Lenders should also have a story to tell. If a lender has a great story, it should tell it.
Think of the $1.6 trillion in originations expected this year. Or the low rates, better credit profile and few foreclosures that mark today’s mortgage marketplace.
Millions of people get financing each year. It’s a process that is not scary or especially hard, but a lot of potential borrowers don’t know that. People still ask if they need 20% down. Lenders, therefore, need to do a better job telling consumers about all the options that are out there, especially the federal programs. They should be mortgage educators.
Lenders need to make a better effort to get to know their borrowers.
It’s an approach that has worked for our company – and it can work for other lenders, as well.
Ray Brousseau is president of Carrington Mortgage Services, where he oversees all aspects of the firm’s lending and servicing divisions.