3% down mortgage announcement more sizzle than meat

Mel Watt’s announcement of 3% down loans pandered to left-wing constituents, but credit standards haven’t changed, and some lenders won’t offer it.

zero_down_mortgageWhenever home sales slow down, people who depend on transactions to make a living cry and complain about tight lending standards. Lending standards are not tight today — they appear tight compared to the complete lack of enforced standards of the housing bubble — but compared to what preceded the housing bubble, credit standards have merely reverted to the normal and prudent standards of the 1990s.

Prior to the housing bubble, lenders verified borrower income and applied rational debt-to-income ratios to ensure repayment, a practice lenders embrace again today. The notion of “tight” lending standards stems from the perceived entitlement to free money by people who have dubious repayment prospects. Lenders will not return to their bubble-era ways any time soon, particularly now that the GSEs and the FHA force lenders to buy back bad loans.

The credit cycle swings between periods of tight credit and periods of loose credit. The periods of tight credit set a standard of price stability; periods of loose credit grow out of the price stability created by periods of tight credit. During the loosening phase, lenders assume more risk and expand loan programs at the fringes. As credit loosens, collateral value rises and lenders have less fear of loss, so they expand their risky offerings further, a self-fueling process whereby risky and unstable loan programs proliferate. Eventually, the instability of the risky loan programs leads to defaults; the defaults cause losses, and the losses cause a credit crunch. The credit crunch leads to tighter and tighter lending standards until collateral values stabilize and the system starts all over again.


Today, we have prudent lending standards and price stability, and affordability problems are causing transaction volumes to fall — a recipe for restarting the credit cycle.

Fannie-Freddie Regulator’s 3% Down Loans Draw Jeers

By Clea Benson Nov 14, 2014

Mel Watt, …, who oversees Fannie Mae and Freddie Mac, unveiled his plan in late October to allow the companies to back mortgages with down payments as low as 3 percent. … Watt said low down-payment loans are a safe way to help families with healthy incomes and meager savings buy homes.

Given that the FHA already offers 3.5% down loans, why do the GSEs need to do this? FHA lending standards are certainly not too tight, and although their costs are high, the private mortgage insurance on 3% down loans may be just as high or even higher because the GSEs use loan-level risk adjustments.

Jeb Hensarling, chairman of the House Financial Services Committee, said …Watt’s proposal is “an invitation by government for industry to return to slipshod and dangerous practices that caused the mortgage meltdown in the first place and wrecked our economy,” Hensarling said in a statement last week. The initiative “must be rejected.”

While this is probably an overstatement, loosening the credit box and allowing low-down payment loans is certainly a step in that direction.

Fannie Mae (FNMA) and Freddie Mac, which purchase about two-thirds of new home loans and package them into bonds, currently allow down payments as low as 5 percent. Fannie Mae accepted 3 percent down as recently as last November before increasing the requirement as part of a tightening of its underwriting standards. Taxpayers bailed out the two companies in 2008.

When the GSEs used to offer 3% down loans, very few people wanted them because the costs were too high. These loans only made up 1% of the origination pool before they were stopped. Why would it be any different this time?subprime_steak

Realistically, it won’t, which is why this announcement is more sizzle than meat.

Robert Toll, executive chairman of homebuilder Toll Brothers Inc. (TOL), called Watt’s proposal “a really dumb” idea during a conference in late October.

Fannie Mae CEO Timothy J. Mayopoulos, responding to critics, told reporters that mortgage rules enacted as part of the 2010 Dodd-Frank act ensure the safety of 3 percent down loans. They will still have to conform to the qualified mortgage rule, which offers lenders protection from legal liability only if borrowers spend no more than 43 percent of their income on debt. The rule also penalizes lenders for risky features such as balloon payments or interest-only payments. …

During a Nov. 7 speech in New Orleans, Watt pointed out that borrowers will need to meet extra requirements, such as debt counseling or stronger credit histories, than are needed for loans with larger down payments.

“The guidelines for these loans will be targeted in their scope and will include standards that support safety and soundness,” he said.

doing nothingThey are both right. The Dodd-Frank rules do make it possible to underwrite these loans safely. In fact, if they aren’t done safely, the originating lender will face a “buyback” request from the GSEs, or they may face an ability-to-repay lawsuit from an aggrieved borrower, so lenders won’t be anxious to use this loophole to start underwriting irresponsible loans.

The problem is not whether or not they can be safely originated under today’s standards; they can. The real problem is whether or not this is the first step on the cycle of loosening that leads to bad loans and a foreclosure crisis.

This is just the camel’s nose under the tent,” said Calabria, a former congressional staff member. “You start with low down payments for high-FICO borrowers, which you can do safely, and it erodes over time. It’s disingenuous or naive to say it’s going to remain with high-FICO borrowers.

Yes, that is exactly what happens, and we must remain vigilant to prevent a recurrence of the problem.

“The backlash shows the political contours of the issue are going to remain complicated,” said Boltansky of Compass Point. The criticism “will just be background noise to the administrative actions, because they’re going to proceed no matter what.”

While it’s true that the GSEs can implement this change without regard to the bluster from Republicans in Congress, some lender must be willing to underwrite these loans for the program to have any impact. Bank of American, one of the largest home loan originators in the country, announced it will not offer these loans.

Bank of America Won’t Loosen Mortgage Standards, CEO Says

By Hugh Son Nov 12, 2014

Bank of America Corp., … will avoid easing mortgage standards even as regulators seek to expand lending, Chief Executive Officer Brian T. Moynihan said.

You won’t see us start to expand our criteria much past what we’ve done today,” Moynihan, 55, said at a New York investor conference sponsored by Bank of America. “I don’t think there’s a big incentive for us start to try to create more mortgage availability where the customers are susceptible to default.”

It’s amazing to me that a major bank CEO feels the need to state the obvious. Apparently, this isn’t obvious to some people. Should banks ever have a big incentive to make loans to customers who will default? Does that sound sane to anyone?


I know that that doesn’t sound good for an instant housing recovery and faster housing markets, but it’s actually good because in the long term it keeps housing more fundamentally based,” Moynihan said.

stupid_and_irresponsibleI respect that he’s arguing against this own book. Bank of America greatly benefited from can-kicking and higher home prices, and it would benefit further if prices could be quickly reflated to housing bubble peaks. For the CEO to make such rational statements is refreshing. It’s like a politician who tells the truth, which is generally considered a gaffe.

Having watched this play out over the last several years, watched the underlying consumer difficulties created by people borrowing more than they could pay back,” the Charlotte, North Carolina-based company’s priority is underwriting loans to people who can repay them, he said.

Wow! Common sense prevails!

This proper banking attitude is a direct reflection of the fact they can no longer pass of this risk to someone else. During the housing bubble, lenders could sell the loans into an MBS pool and forget about it. Now, the threat of buybacks and borrower lawsuits focuses banker’s attention on sound underwriting, which is where it should be.

A customer without the means to make a down payment of at least 10 percent should consider renting rather than trying to buy a home, Moynihan said.

I couldn’t agree more (See: The minimum down payment should be at least 10%)

I wonder if Mr. Moynihan reads the blog?

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