Despite industry spin, mortgage lending standards are not tight
Real estate industry lobbyists foster the false impression mortgage lending standards are tight. They are not.
Real estate industry lobbyists appeal to lawmakers for policies the real estate industry believes will promote more transactions at higher prices. Most often this lobbying is short sighted and causes unintended long-term detrimental impacts on the housing market.
For example, real estate industry lobbyists continually support relaxed lending standards. In 2004 they watched all of their dreams come true as all mortgage standards were abandoned causing a large boost in transaction volume and much higher home prices. Rather than being the panacea they envisioned, the abandonment of lending standards inflated a massive housing bubble that pulled forward demand, caused a deep house price crash, lowered home ownership rates to 20-year lows, and caused an 80% reduction in new home construction — a condition the industry has not recovered from.
Rather than learn an important lesson from this disaster, real estate lobbyists continue to pepper the press with complaints about how tight mortgage standards are today with hopes that policymakers will lower standards at the FHA and GSEs to promote more transactions by making bad loans to people who won’t repay them. In short, they learned nothing; lobbyists still promote short-term goals at the expense of long-term stability. And the worst part is they are completely wrong about mortgage standards being tight today.
The world is awash in inaccurate sound bites related to mortgage credit. We spoke with numerous industry executives and identified three truths that need to be clarified:
1. Low income buyers actually have it easy. Buyers with poor credit and low income are finding it quite easy to buy a home below the FHA limit.
People with FICO scores below 620 can obtain FHA loans with only 3.5% down. FHA standards are not much above subprime.
2. Many affluent buyers find it very difficult. Automated underwriting prevents many highly qualified borrowers, especially affluent retirees, self-employed, or commissioned salespeople from getting a mortgage because their income situation does not fit squarely in the credit box.
This truth is counterintuitive because affluent borrowers who do qualify make up a higher percentage of today’s sales than normal. This is not because standards are too lose for them, it’s because so few lower-income households have the income or down payment necessary to buy a home.
3. Industry executives are unintentionally preventing a recovery. Mortgage industry executives lobbying for the good old days where FHA limits were higher, fees were lower, and documentation was easier need to stop whining because they look very unreasonable to regulators and politicians who are not sympathetic.
This is a surprisingly blunt and accurate statement. Whining industry lobbyists are asking for the very things that caused the housing bubble and ensuing crash.
Our purpose here is to shed some light on what is actually happening—because if there were clarity around this, we would have:
1. More entry-level home buyers. Many qualified people are not even shopping for a home because they presume they cannot get a mortgage. We provide several examples of easy qualification below.
2. More affluent home buyers. More good loans to very qualified buyers would be made if underwriters were allowed to use good business sense rather than fill in automated forms. As we did our research, we heard many stories of buyers reluctantly paying cash or deciding not to move at all and telling their friends who then also elect not to move. These include business owners, retirees, and commissioned salespeople.
3. More relocating home buyers. Many relocating employees are renting simply because they cannot provide historical pay stubs at their new employer. Given their track record of steady employment and desirability to multiple employers, does that make any sense?
One of the main reasons I did not buy a home in late 2011 was because I didn’t have qualifying W2 income, and it would have been very difficult to obtain a loan.
In the aftermath of the housing crisis, the reality is that we are lending aggressively to the poor and conservatively to the rich. While the Dodd-Frank rules were written with good intent, let the truth be known, so more first-time buyers can take advantage of current programs to buy homes. Let the bankers use good judgment again, so more affluent buyers can get a mortgage.
Easy Money through FHA
FHA federally insures 95%+ loan-to-value (LTV) mortgage loans made to people with poor credit and low incomes.
Here are three recently approved loans, all through FHA or VA:
1. Recent foreclosure. 96.5% loan on a $170,000 house to a couple with $36,000 in income, a foreclosure three years ago contributing to their 620 FICO score, and debt service equal to 55% of their gross income
2. 57% of income needed to pay debts. 96.5% loan on a $165,000 home to a couple with $38,000 in income, a 642 FICO score, and debt service equal to 57% of their gross income
3. Fixed income and disabled. 100% loan on a $160,000 home to someone permanently disabled with a 601 FICO score and a $34,000 fixed income
Does that sound like tight lending standards, or does it sound like a return of subprime? Each of those loans profiled is high-risk, and the chances of default are high, yet our government chose to back them.
Tight Money above FHA Limits
Affluent commissioned salespeople, self-employed, newly employed, and retirees who don’t have steady paychecks have tremendous difficulty getting a mortgage because they either: report inconsistent income to the IRS, cannot provide extended income history from a new employer, or do not have sufficient current income to qualify but are trying to keep some cash in the bank or delay paying taxes on an IRA distribution.
Here are six borrowers who were denied a mortgage:
1. 27% LTV. A couple with a 780 FICO score who wanted a $300K loan on a $1.1 million house and would have $300K in reserves after closing, but whose verifiable income was only 30% above the proposed mortgage payment.
2. 801 credit score. Newly retired couple with fantastic 801 credit score, $1 million in retirement accounts, and $400,000 in savings after they were going to put down $350,000 on a $550,000 home purchase, but whose Social Security income was less than double the proposed mortgage payment.
3. Affluent business owner. Owners of a small retail business who were turning the business over to their children to manage, with the intent of collecting dividend income; who had $500K in cash savings and wanted a 50% LTV.
4. Relocating borrower. A US citizen who has been working overseas takes a job in the US, has a 700 FICO, 20% down payment, and plenty of reserves, but cannot produce a W-2 because he does not exist in the country in which he was working and hasn’t started his new job yet.
5. New employee. A prospective borrower qualified in every way except she had only been in her current job for five months and had worked in the family business previously where she did not get a W-2.
6. Loan = 15% of applicant’s assets. A retiree who wanted a 50% LTV and had assets six times the proposed loan amount was turned down and eventually paid cash.
Mortgage Industry Vets Tell It Like It Is
We expect the borrowers and outcomes profiled above will be surprising to many. We also want to share the following sound bites from mortgage industry veterans to offer surprising clarity on other areas of debate:
Loans today are easier than the 1990s. “For the average borrower, I believe it was more difficult to qualify for a mortgage in the 1990s.“
That’s an astonishing statement given the spin we read in the financial media.
Huge improvements are being made in conforming loans. “For a while, if you didn’t have a credit score over 720 and you wanted a loan with less than 20% down, you were pretty much looking at an FHA loan. During this period, it’s fair to say that sales were being seriously impacted by 20%+. Slowly at first, and now more rapidly, things are changing. Credit requirements for 95% conventional financing are as low as 620, and MI companies have lowered premiums and relaxed guidelines. Banks have been peeling back overlays. You aren’t likely to get a conventional loan with a ratio above 45% anymore, but nor could you really get that back in the 90s either.”
The standard most responsible for borrower default is the high back-end DTI ratio. Nobody can afford to consistently pay more than 43% (the standard is 43% not 45%) without running a personal Ponzi scheme. These loans weren’t made in the 90s, they aren’t being made now, and hopefully, they will never be made again.
Disposable income is more important than gross income. “Our industry needs to focus more on disposable income versus debt-to-income ratios, meaning a borrower who makes $2,200 a month with a 40% debt-to-income ratio is more risky than someone who makes $12,000 a month with a 50% debt to income ratio. The first borrower has very little cushion after income taxes, utilities, car insurance, food, etc. for emergencies. But the person making $12,000 a month would have much more left over after all of these other debts.”
While their argument is sound, the focus on DTIs with a rigid cap is a sound safeguard in the system. Once you make that barrier flexible, it won’t take long before lenders completely ignore it and begin funding personal Ponzi schemes. Further, this does nothing but inflate house prices at the high end; it doesn’t make for any sustained increase in sales volumes.
Stated income should have its place. “There is a time and a place for Stated Income, not “No Doc” loans, but Stated Income loans. They were a great tool back in the 2000s that rarely went bad if they were used properly because the borrower had a lot of their own capital invested in the home.”
Sorry, but that one is bullshit. Stated-income loans have no place. They were called liar loans for a reason, and the presence of these loans, more than any other, caused the credit crunch of 2007. When investors realized they couldn’t trust the underwriting in the mortgage pools they were buying, they abruptly stopped buying them. This caused a cascade reaction where investors began to question all loans and stopped buying them. The private securitization market still hasn’t recovered.
Income is the problem. “The challenge is not credit based, it’s income based. Home valuations have increased at a steeper trajectory than income. Also, the new buyer pool is saddled with student loans and other debt, which has really created the (disposable) income issue. I believe credit is much more accessible than the media/public portrays (in terms of credit scores, LTV’s, etc.) My opinion will remain our immediate challenge is income/debt/DTI.”
Yes, the problem is one of income and down payment. The recession wiped out the meager savings of many potential homebuyers, and the lingering unemployment is keeping wage growth in check. I know I’ve said it a million times, but the housing market won’t have a true fundamental recovery without strong job and wage growth. Period.
In conclusion, let’s:
1. Get the word out that loans below the FHA limit are readily accessible, with monthly payments that are a great historical value in comparison to gross incomes.
2. Let the bankers use manual underwriting in instances where they can document that the loan has a very low likelihood of losses.
I don’t believe consumer education is the answer. Lenders constantly advertise for business, and I don’t believe anyone considering buying a house who has a sufficient down payment doesn’t at least talk to a lender about getting a loan. I think the real reason for the lack of low-end sales volumes is the lack of a 3.5% down payment. If people don’t have that, there isn’t much point in shopping for a loan.
The second point about allowing manual underwriting is a red herring. Banks who make non-conforming loans to hold on their own balance sheets can use any standards they want; they are not bound my automated underwriting standards. The only lenders limited by these standards are correspondent lenders who plan to obtain government backing for the loan and sell it into the secondary market. Those loans should be limited by automated standards because once you start allowing exceptions, the trickle becomes a flood, and lenders will stuff all kinds of bad loans into that loophole.
Looser lending standards won’t improve sales much, but they would increase risk to the US taxpayer. What the real estate industry needs is a strong economy with good job and wage growth. Until we get that, the housing market will remain in the doldrums.