Potential Homebuyers Thwarted by Credit Crunch
The tightening of mortgage credit standards served its purpose after the collapse of the housing bubble, but mortgage credit remains so tight that it is hindering the housing recovery. The Urban Institute estimated that the difference between 2001 and 2012 standards cost the industry an extra 1.2 million mortgage loans in 2012.
Credit scores from Freddie Mac’s guaranteed loans last year averaged 742 – better than the previous year’s 756 average but far above the traditional minimum of 620 and well above historical averages.
The Federal Housing Finance Agency (FHFA), the agency that assumed responsibility for Fannie Mae and Freddie Mac during the financial crisis in 2008, has been trying to find a way to persuade banks to expand lending to those who are still reasonably qualified but pose a bit higher risk. Banks have said thanks, but no thanks. They have seen this movie before, and they do not like the ending.
Lenders Reportedly Reach a Deal with Fannie and Freddie
Having been forced in the past to buyback mortgages and pay penalties over questionable loans, banks are keeping their loan criteria well above that of Fannie Mae and Freddie Mac to maintain a margin of safety. Potential homeowners are extremely frustrated since they cannot take advantage of low interest rates because of marginal loan qualifications.
However, Fannie Mae and Freddie Mac appear to have reached a tentative deal with lenders to relax credit standards and bring the next tier of homeowners into the marketplace. The deal was reached after discussions between lenders, FHFA regulators, and Fannie/Freddie that were set up by the Mortgage Bankers Association.
Banks expect stricter guidelines as to when they must repurchase bad loans – they consider the guidelines fuzzy and are still in full risk aversion mode. FHFA has been shifting the guidelines attempting to ease the pressure on banks, with minimal success.
In 2013, the FHFA ruled that as long as borrowers were making payments over the first three years, loans had to be clearly fraudulent or the qualifications of the borrower had to be seriously overstated to be a repurchasing candidate; in 2014, the rule was extended to include the possibility of two 30-day delinquencies. Presumably, these guidelines will be clarified. It is not known if they will be loosened any further.
The other major change is a reduction of the minimum down payment required for Fannie and Freddie to be able to purchase loans. The typical 5% minimum for qualification will reportedly be dropped to 3%.
Private mortgage insurance (PMI) should still be required, as it generally is for all down payments below 20% – but even with PMI, the lesser down payment should enable more lower and middle-income families to qualify for mortgages.
To the surprise of nobody, reactions to the proposed deal are mixed. Chief Economist Mark Zandi of Moody’s Analytics calls the agreement “vital to getting the housing recovery moving forward.” Meanwhile, critics are calling the potential moves a slippery slope toward the conditions that started the housing crisis in the first place. The deal may be a hard sell in parts of Capitol Hill – Sen. David Vitter (R-La), channeling Yogi Berra, said, “This is like déja vu all over again of what prompted the financial meltdown in 2008.”
There certainly is reason for concern – but it is also true that credit truly is unusually tight and needs to be loosened somewhat to keep the housing recovery from being throttled. We hope that a fiscally responsible middle ground can be reached between irresponsible and overcautious lending. A meaningful housing recovery and solid economic growth depend on it.
A responsible loosening of mortgage credit should be good for both the housing market and the broader economy. By itself, however, a housing market uptick is unlikely to trigger interest rate moves from the Fed, thus investors should expect positive market effects in the short term.
Meanwhile, if you are at the margins of loan qualification, this can only be good news for you. We hope that the credit changes proceed as advertised and that you are able to take advantage of today’s unusually low interest rates.
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