Credit standards are not tight by historic standards. Compared to the complete lack of enforced standards of the housing bubble, credit is very tight, but compared to what preceded the housing bubble, credit standards have merely reverted to what was normal. Prior to the housing bubble, lenders verified a borrower’s income and made sure the payment burden was manageable to ensure the loan was repaid. Today, lenders are doing the same. The notion of “tight” lending standards stems from the perceived entitlement to free money by people who have dubious repayment prospects. There is little reason to believe lenders will return to their bubble-era ways any time soon, particularly now that the GSEs and the FHA who control more than 90% of the mortgage market are forcing lenders to buy back bad loans when there is the slightest deviation from their standards.
The credit cycle swings between periods of tight credit and periods of loose credit. The periods of tight credit set a standard of stability, and periods of loose credit grow out of the price stability created by the period of tight credit. During the loosening phase, lenders take on 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. The continuing expansion of credit becomes self-fueling, and 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.
Financial reporters with their optimism bias and the housing bulls looking for any reason to reaffirm their faith in ever-increasing house prices hope to see the beginnings of the next loosening cycle in credit. Unfortunately, credit markets don’t move that quickly. Lenders are still dealing with the loss of trillions of dollars in collateral value from the bad loans they made last time. And since they haven’t been able to escape all responsibility for their losses both past and present, lenders are very cautious about who they loan money to. That isn’t likely to change any time soon. Private money is not ready to fuel another housing bubble, and government-backed mortgages require stringent standards likely to become even more stringent given the huge losses at the FHA and the GSEs over the last six years. No, credit standards won’t be loosening up in 2013.
December 20, 2012, 12:22 PM
Credit standards are tight. Yes, the Federal Housing Administration allows borrowers with credit scores of less than 700 and down payments of just 3.5% to buy homes.
Does anyone else see the contradiction in the two sentences above? The FHA allows FICO scores below 600, and a 3.5% down payment provides no cushion for loss in the event the borrower defaults early in the loan period.
But lenders are still scrutinizing property appraisals, reams of income and bank statements, and anything else that could be used to force them to buy back the loan should it default, which means that it is much harder to get a loan than at any time since the 1990s.
In other words, lenders have gone back to doing their jobs because they have consequences for their failures. Amazing how accountability changes things.
Rising home prices could eventually serve as a tailwind for credit.
That’s the delusion of price security lenders rely on. The entire subprime business model with its sky-high delinquency rates depended on rising prices to minimize their default losses. We all saw how that turned out when prices fell.
But it’s not clear how aggressive lenders will be in easing their standards as long as they have plenty of business—which they do right now thanks to heavy refinancing volumes from low interest rates.
There are other factors that are likely to keep restraints on mortgage lending next year.
While there have been some fears in the banking industry that a series of new regulations that are part of the Dodd-Frank financial-overhaul law would further tighten lending standards, a more likely result is that those regulations keep today’s lending rules in place.
In addition, financial troubles at the FHA, which has played an outsized role facilitating new lending, could lead that agency to crack down on lenders and take other steps that make credit more costly at the margins.
The upcoming FHA bailout will almost certainly increase costs on FHA loans and further tighten lending standards. This will become a political firestorm in 2013 as we debate whether to reflate the housing Ponzi scheme with government-backed loans or do we let the so-called housing recovery weaken by raising costs to first-time homebuyers.
Another challenge facing the mortgage industry is that several large banks have reduced their appetite for buying mortgages from smaller lenders, drying up credit for so-called “correspondent” lending. While new players are rushing into the void, they’re not large enough to replace the capacity that has been lost over the past few years. Community banks and credit unions have also ramped up lending and can offer more flexibility, but they’re also too small to move the needle on credit creation.
Big lenders have been reducing their footprint amid growing legal expenses and put-back costs from their legacy loans
The put-back provisions are the primary tool for protecting the US taxpayer from further loss exposure. These provisions are also what keeps credit standards prudent today.
and as new international capital standards are implemented forcing them to hold more capital.
The banks are largely in compliance with the new Basil III capital lending standards.
Banks also aren’t eager to invest in building capacity because origination volumes are likely to fall whenever mortgage rates rise from their current levels, which are the lowest on record.
If originations are likely to fall, why does everyone think sales volumes and prices are going to go up?
Banks have engaged in defensive underwriting for the past few years, scrutinizing any flaws with a loan file to avoid the risk that they’ll have to repurchase the loan from Fannie Mae or Freddie Mac if it defaults. So-called “put-backs” of bubble-era mortgages have cost banks billions of dollars.
Good. Then perhaps they won’t inflate a new bubble doing the same stupid things that inflated the last one.
There are signs that lenders could ease some at the margins, but overall, buyers shouldn’t expect that getting a loan will get easier anytime soon, even though rates probably can’t get much more attractive.
That’s the contradiction of the credit cycle. When interest rates are the most attractive, the borrower pool is the smallest. That is also typically a signal that it’s a good time to buy because as lenders loosen credit standards in the future, more borrowers will enter the market and bid prices up, assuming interest rates don’t rise too far too fast.
America’s lawmakers may finally take reforming housing finance seriously in 2013. Assuming Congress settles the deficit debate, sorting out the government’s role in funding home loans should be its next stop. And a number of obstacles are dissolving.
U.S. taxpayers are on the hook for at least 90 percent of the nation’s mortgages through Fannie Mae, Freddie Mac and the Federal Housing Administration – a dramatic increase since 2007. But Frannie’s guarantee fees are now so low that private lenders cannot compete to wrest back market share.
Increasing the fee is the simplest policy fix. But that doesn’t wholly address the future role for Fannie and Freddie, which between them needed $188 billion of taxpayer aid to stay afloat. The general consensus is that they should be wound down – even some Democrats and the Treasury are on board.
But there’s no plan of action because the environment seemed too tricky. That’s now changing. The housing market is recovering. Home prices and existing home sales have risen steadily this year while inventory fell to a 10-year low.
Some regulatory certainty is coming as well. The Consumer Financial Protection Bureau should finalize what constitutes a qualified mortgage in January. This will exempt lenders from certain lawsuits. That will then enable the Federal Reserve and five other watchdogs to define the meaning of a “qualified residential mortgage” that will set standards – such as how much equity a borrower has in a property – for prime loans that lenders won’t need to retain a chunk of. New documentation standards will also improve transparency.
So banks and investors should feel comfortable taking on more mortgage risk. Meanwhile, Congress now has an advocate who wants mortgage reform front and center: incoming House Financial Services Chairman Jeb Hensarling.
Some hurdles remain. Industry lobbyists will make a stink about reform. Lawmakers can still make dumb decisions. And any new financing framework is likely to be implemented over several years to avoid a crash. But if lawmakers don’t realize that 2013 is a prime time to take up housing reform, it’s hard to imagine when they ever will.
I doubt Congress will take up GSE reform. The lobbyists representing the parties benefiting the most from the current system will argue that any changes will endanger the housing recovery. They will be right in their assertions, so Congress will kick the can for another year or two. We may see some broad “roadmap” to reform announced by Congress, and that would be a start, but I rather doubt any substantive will be done until the bottom callers become less nervous about their prognostications.
This is why credit standards are tighter today
The former owner of today’s featured property should never have been given her Ponzi loans. She steadily extracted the equity from her property, then she quit paying when the Ponzi money stopped coming. She is the poster child for why standards need to be tighter today.
- This property was purchased for $250,000 on 4/15/1999. The owner used a $237,500 first mortgage and a $12,500 down payment.
- On 10/20/1999, only six months later, she obtained a $30,000 HELOC and extracted her down payment and them some.
- On 1/30/2002 she refinanced with a $260,000 first mortgage.
- On 4/23/2002 she obtained a $46,200 HELOC.
- On 1/30/2003 she refinanced with a $322,700 first mortgage.
- On 10/2/2003 she opened a $79,700 HELOC.
- On 3/1/2004 she refinanced with a $405,000 first mortgage.
- On 6/22/2004 she obtained a $100,000 HELOC.
- On 6/24/2005 she refinanced with a $560,000 Option ARM with a 1% teaser rate.
- Total mortgage equity withdrawal is $322,500.
- She quit paying the mortgage in late 2009, and she has been allowed to squat for three years.
Wouldn't you be embarrassed to overpay by $100,000? Only fools buy houses without knowing neighborhood values. Don't be a fool. Don't suffer the pain of an underwater mortgage. The surest way to lose your house is to overpay for it. Our reports identify overvalued and undervalued neighborhoods. Use it to broaden or narrow your search area. Savvy buyers work with us to find bargains. We've saved thousands from financial ruin. Let us save you too. If you want peace of mind while shopping for your next home, sign up for our monthly market newsletter.
We're sorry, but we couldn't find MLS # S721244 in our database. This property may be a new listing or possibly taken off the market. Please check back again.
Proprietary OC Housing News home purchase analysis
$465,000 …….. Asking Price
$250,000 ………. Purchase Price
4/15/1999 ………. Purchase Date
$215,000 ………. Gross Gain (Loss)
($37,200) ………… Commissions and Costs at 8%
$177,800 ………. Net Gain (Loss)
86.0% ………. Gross Percent Change
71.1% ………. Net Percent Change
4.5% ………… Annual Appreciation
Cost of Home Ownership
$465,000 …….. Asking Price
$16,275 ………… 3.5% Down FHA Financing
3.41% …………. Mortgage Interest Rate
30 ……………… Number of Years
$448,725 …….. Mortgage
$115,323 ………. Income Requirement
$1,993 ………… Monthly Mortgage Payment
$403 ………… Property Tax at 1.04%
$0 ………… Mello Roos & Special Taxes
$116 ………… Homeowners Insurance at 0.3%
$467 ………… Private Mortgage Insurance
$0 ………… Homeowners Association Fees
$2,979 ………. Monthly Cash Outlays
($294) ………. Tax Savings
($717) ………. Equity Hidden in Payment
$17 ………….. Lost Income to Down Payment
$136 ………….. Maintenance and Replacement Reserves
$2,122 ………. Monthly Cost of Ownership
Cash Acquisition Demands
$6,150 ………… Furnishing and Move In at 1% + $1,500
$6,150 ………… Closing Costs at 1% + $1,500
$4,487 ………… Interest Points
$16,275 ………… Down Payment
$33,062 ………. Total Cash Costs
$32,500 ………. Emergency Cash Reserves
$65,562 ………. Total Savings Needed