Editor's Note: This article was published in RealtyTrac's Housing News Report publication. RealtyTrac and Dr. Rosen granted Collections & Credit Risk permission to run the article. For the full report, click here.
We are coming out of a period of historically low interest rates and historically low house prices. Unfortunately, private equity firms and other investors were better able than average citizens to purchase homes at bargain prices.
Now, interest rates are creeping up and home prices gained 10% in value in each of the past two years. We worry that this rare opportunity to encourage homeownership for low- and moderate-income individuals has been squandered.
We are specifically concerned that young people today who are approaching their thirties rather than being ready to think about home ownership are just barely out of their parents house and getting their first apartment.
The housing market functions as a virtuous circle, starting with the first-time homebuyer and progressing to the trade-up buyer and on to the downsizing buyer. This much stickiness in the housing market creates systemic problems that perpetuate sluggish sales.
While low savings for down payments are part of the problem, the larger impediment for first-time and low-and moderate-income homebuyers is the current state of the mortgage market. Currently, the federal government is supporting nine out of 10 loans, with private lenders only lending to the very well off.
Unfortunately, the federal government is similarly focused on borrowers with credit scores of 760 and above. GSE borrowers FICO scores have elevated to more than 750 from an average 723 in 2003. Worse, FHA borrowers FICO scores have increased to 698 in 2013 from an average of 658 in 2009.
Credit this tight leaves far too many potential buyers on the sidelines. At the same time, new regulations have come online as of January 2014 that are reframing the mortgage underwriting process. The Consumer Finance Protection Board under Dodd-Frank has defined what it considers a qualified mortgage or QM. Further encouraging the current Federal dependence, a loan is automatically considered QM if purchased by Fannie Mae or Freddie Mac.
We do understand, of course, that tight credit conditions and new Federal standards are in response to the 2008 mortgage bust. The 2004 to 2008 period was a highly unusual period of high risk driven by the expectation that house prices would continue to rise.
When house prices reversed nationally for the first time since the Great Depression, both risky-loan products that categorized that era and traditional loans went delinquent as home values slipped below the amount homeowners owed on their mortgages. In the aftermath, many families, individuals and investors lost their homes, with more than 4.5 million foreclosures. The worst credit damage was done to low- and moderate income households.
Dodd-Frank was passed to outlaw the bad loan products that made that era so dangerous, and to create a future system that would be safer for consumers and that would protect the U.S. taxpayer. That the bad loan structures subprime, Alt-A, short-term hybrid ARMS, low documentation and interest-only (outside of the jumbo market) have been eliminated is a good thing.
That we have created a system where credit is limited to those who are better off is simply not sustainable going forward. Far from being the norm, the 2004 to 2007 bubble years were an aberration in five decades of successful lending. As more than 40 years of experience proved, credit can be made widely available with strong underwriting and good performance.
We are concerned, however, that a new mortgage finance system is being built that will only sustain todays tight credit conditions. The new regulations increase the cost of making a loan and decrease lender discretion.
Traditionally, before the dominance of credit scores, a lender would look at employment, income and other compensating underwriting factors to approve a loan. Under the proposed rulings, lenders will be looking for each borrower to achieve certain parameters for QM safe-harbor and deem other borrowers ineligible.
Historical practice is evidence that many working families and individuals can qualify on the basis of income and assets that otherwise do not meet todays excessive FICO and debt-to-income (DTI) terms.
Before the economic downturn, a 620 FICO with 5% down was an insurable prime loan. In todays conventional market, 680 is the new 620. That line of demarcation is simply too high and squeezes too many families into higher-cost loans or out of the housing market completely.
We are concerned that many low-and moderate-income families will be forced to remain renters not by their own choice, but as a result of the cumulative impact of regulatory rules seeking to create a limited-risk environment.
An important element of the 40-odd successful years of mortgage lending was that there was both a robust primary and secondary market for mortgages. Because so many of the bad loan products were securitized and defaulted in the mortgage bust, there is concern about restarting the securitization market. Securitization, we would argue, is critical to broadening access to credit.
In the 1980s and 1990s, the expansion of agency securitization and growth of private securitization made 30- and 15-year loans available across the country at the same interest rate. Previously, there was tremendous
regional variation and areas of the country where families could not get a mortgage. Access to credit was increased through the originating and pooling of a range of credits from stronger to somewhat weaker that resulted in the creation of mortgage-backed securities that offered both good profitability and an acceptable, predictable, low delinquency rate.
It is our belief that the combination of pooling and securitization will create good performing loans, a profitable business for the lender, attractive risk/return options for investors and access to credit to the widest number of potential borrowers.
It is important to recognize that even in the prior more-open credit environment, homeownership was more accessible to white, higher-income, traditional family households than minority households. The Home Mortgage Disclosure Act shows the problem both in far fewer applications by African Americans and Hispanics, and still-fewer originations (a reflection of stringent credit policies). African Americans represented only 3.8% of applications and 2.3% of originations in 2012.
Hispanics represented 5.9% of applications and only 4.9% of originations. All one need do is look at the diverse and multicultural nature of our nation; the Joint Center for Housing Studies of Harvard University projects communities of color will account for more than 70% of net household growth between 2013 and 2023.
The mortgage finance system is simply not keeping up with todays reality. We believe that changes can be made to the current system to make it more equitable and for the greater good of the housing market and the economy.
1. Ensuring that the Qualified Mortgage provides access to low- and moderate-income families;
2. Ensuring that the mortgage finance system utilizes pooling of risk and securitization to expand opportunity and to create investment options;
3. Ensuring that the system builds and supports a pipeline of future home buyers that are willing to save and improve their credit quality for homeownership; and
4. Ensuring that the system achieves access for first-time home buyers and low-and moderate-income buyers with loan products and terms that result in few foreclosures.
Dr. Kenneth T. Rosen is chairman of the Fisher Center for Real Estate and Urban Economics and Professor Emeritus at the Haas School of Business at the University of California, Berkeley.