Mortgage lending standards continued to tighten in 2013
Realtors, builders, mortgage brokers, basically anyone with a financial interest in a real estate transaction is complaining that lending standards are too tight. From the beginning of these complaints four years ago, it’s all been complete bullshit. Lending standards were completely abandoned during the housing bubble as all the parties allowed greed to overcome their better judgement. Any return to sane standards was going to require tightening — a lot of it.
The market first reacted to a huge wave of defaults by tightening standards suddenly and violently in a massive credit crunch in August of 2007. This effectively dried up funding for the most toxic loan products and caused loan balances to plummet. The lower loan balances translated to lower home prices.
Credit standards needed to tighten for one simple reason: lenders were giving loans to people who weren’t paying them back. Until lenders successfully screened out deadbeats, credit was doomed to tighten further. The credit crunch was just the first step. Once the spell was broken and lenders recovered their senses, credit was tightened incrementally over time to prevent further delinquencies and associated losses.
To suggest that credit standards are tight today is to feign ignorance to the history of lending standards. Sure, compared to the housing bubble’s complete lack of standards, today’s underwriting guidelines are tight, but compared to any other time in mortgage lending history, today’s standards are still loose. Prior to the housing bubble, borrowers had to come up with a 20% down payment unless they were using an FHA loan — which had tighter standards then as well (FHA standards were eased to qualify more buyers when it became the substitute for subprime when the housing bubble imploded). High down payment standards, rigorous income verification, and high FICO score hurdles were standard fare before the 00s. The so-called tight standards of today are not tight at all by historic norms.
So despite the chorus of transaction-dependent whiners constantly complaining in the media about tight standards, mortgage qualification standards continue to tighten, and they will continue to do so until people stop defaulting at rates higher than historic norms. We’ve taken a meaningful step toward reestablishing normalcy with the implementation of the qualified mortgage rules. I believe the new mortgage regulations will prevent future housing bubbles. We will see more tightening when the standards for the qualified residential mortgage are announced soon. In the meantime, analysts are looking at the potential impact of these new standards, and those hoping for a loosening of standards do not like what they see.
It’s no secret that banks have tightened up mortgage-lending rules over the past four years after lax standards inflated the housing bubble during the middle of the last decade.
But data from research firm CoreLogic show that just 52% of all mortgages made in 2010 would have met the definition for the safest loans under the “qualified mortgage” rule recently set out by the Consumer Financial Protection Bureau. Loans that meet the “QM” standards for a safe harbor will satisfy new legal liabilities banks face to ensure that borrowers have the ability to repay their mortgage.
I suspect the 48% that wouldn’t have met the standards were FHA or GSE loans which are given an exemption.
Ostensibly, the federal government wants to reduce the footprint of the FHA and the GSEs on the mortgage market. The new safe harbor rules permitting exceptions for FHA and GSE loans will ensure these entities will continue to dominate mortgage lending for quite some time.
Certain loan products, including those that have initial “interest-only” periods that allow borrowers to defer principal payments, don’t meet the QM standard. Borrowers’ total debt payments can’t exceed 43% of their pretax income, a restriction that knocks out 24% of all originations from 2010.
We are still going to see future foreclosures from the 2007-2012 era loans that permitted DTIs in excess of 43%. Borrowers simply cannot afford such large debt service burdens. Anyone with a DTI higher than that is foregoing all other forms of savings and investment to service their debt.
Recognizing the potential bite of such a definition on mortgage credit markets, the CFPB created an alternate way for lenders to satisfy the QM test: If a loan is eligible for sale to Fannie Mae Freddie Mac or the Federal Housing Administration, it will be considered a QM. That waiver expires in seven years, or whenever Fannie and Freddie exit their government-run conservatorship, whichever comes first.
Jumbo mortgages that are too large for government backing aren’t eligible for that second option, and CoreLogic finds that nearly one-third of jumbo mortgages issued in 2010 wouldn’t have been deemed QM. A separate report published last week by Deutsche Bank estimates that 75% of jumbo loans issued before 2010 were not QM, and that 13% of the jumbo loans issued since 2010 would not be QM.
The jumbo loan market is still headed for trouble. These new restrictions will further restrict credit and thin out the buyer pool. We have way, way to many homes valued at jumbo loan prices, far more than we have qualified buyers. I believe the $900,000+ market will languish for a decade or more — once lenders start processing their huge backlog of jumbo loan delinquencies (see: Delinquent jumbo loans in Coastal California pollute bank balance sheets)
Regulators have yet to issue a separate definition for the “qualified residential mortgage,” which will be exempt from requirements that banks hold more capital for mortgages that are pooled and sold off to investors as securities. If that “QRM” definition includes an additional requirement for a 10% down payment, then nearly 60% of loans made in 2010 wouldn’t satisfy both the QM and QRM definition, according to CoreLogic.
And what if the qualified residential mortgage mandates a more reasonable 20% down payment?
It’s a rhetorical question. I think we all know it will further weaken the market and cause the so-called recovery to fade away.