Mortgages: Too Much Risk?

There’s constant pressure in the mortgage marketplace to make financing quicker, easier and more broadly available. After all, with reduced lending requirements, we did sell more than 7 million existing homes in 2005, which was about 1.5 million more units than we expect to market this year. Surely it would make sense to ease credit standards now to pump up home sales, right?

According to the Urban Institute, there were an additional 5.2 million loans that could have been made between 2009 and 2014 had we used 2001 qualifying standards –  standards that created a super-safe mortgage marketplace.

“The market is taking less than half the credit risk it was taking in the pre-crisis period,” said the institute in a 2016 report. “The factors contributing to the tight credit box are complex, ranging from the issue of lender overlays due to repurchase risk, to the high costs of servicing delinquent loans, to fears of litigation by the Department of Justice, the HUD inspector general or state attorneys general.”

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But what if we’re having fewer originations today not because loan standards are too tight, but because lenders are simply being prudent? Isn’t prudence a far better financial sin than an orgy of low standards that might lead directly to another mortgage meltdown?

Mortgage rates

The fastest and surest way to expand the credit box is simply to have mortgages available at low rates, and that’s precisely what we have today. The annual mortgage rate for 2016 was 3.65% – the lowest on record – versus 6.97% in 2001.

If you’re a mortgage investor, it’s not your job to pump up home sales. Instead, it’s to find the best combination of risk and reward for your capital in the current marketplace.

Today’s mortgage rates have opened up the real estate marketplace to huge numbers of people who otherwise could never get financing. According to Lawrence Yun, chief economist with the National Association of Realtors, each 0.1-percentage-point mortgage rate increase results in 35,000 fewer sales. If mortgage rates went from 4% – roughly the rate as this is written – to 7%, we could expect to see market activity reduced by 1 million transactions.

Relaxed credit standards

Why are mortgage rates so low? Because investors see little risk in the U.S. housing market as a result of today’s lending standards. In the first quarter of 2016, the foreclosure starts rate was at the lowest level since the second quarter of 2000, according to the Mortgage Bankers Association.

The reality is that lending standards have eased considerably in recent years. The Mortgage Credit Availability Index (MCAI) from the Mortgage Bankers Association was at 174.2 at the start of this year versus 83.2 at the end of 2008.

Are there concrete examples of eased credit standards? You bet. Fannie Mae will now buy loans with 50% debt-to-income ratios without certain compensating factors. Freddie Mac’s Home Possible program allows borrowers to qualify with just 3% down.

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“Can we ease lending standards even more?” asks Rick Sharga, executive vice president at online real estate marketplace “Absolutely. But the goal of lending is not to increase mortgage production at any cost; it’s to find the right balance between risk and reward, so any easing of credit requirements needs to be done thoughtfully and carefully. Even in today’s relatively tight credit market, we’re seeing strong home sales and rising prices. Slightly looser credit might accelerate sales but shouldn’t do so by increasing the risk of another foreclosure crisis.”

Income and debts

The reality is that lenders have every reason to favor conservative application standards because while home prices have soared, incomes are flat and debts are rising.

The National Association of Realtors reports that existing-home prices in June reached $263,800. That’s up 6.5% in a year and represents the 64th straight month of year-over-year increases. The median price for new homes reached $310,800 in June.

Meanwhile, household incomes in 2015 were lower than in 1999, and debts are soaring: According to a May report from the Federal Reserve Bank of New York, total household debt reached $12.73 trillion in the first quarter of 2017, which eclipsed the $12.68 trillion peak reached during the recession in 2008.

As a lender, you have to wonder at what point the combination of higher home prices, rising debts and stalled income represents too much risk. It’s not that lenders are prudent to be mean: It’s because the market has real dangers, and too much credit relaxation could bring us to a new mortgage meltdown. That’s something that benefits neither lenders nor borrowers.

Peter G. Miller is a nationally syndicated newspaper columnist, the original creator and host of the AOL Real Estate Center, and the author of numerous books published by Harper & Row.


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