It's gotten tougher and tougher to get a mortgage, at least that's the story we commonly hear. So is it time to relax loan standards so that more borrowers can enter the housing market?
The answer from Federal Reserve Governor Elizabeth A. Duke
is yes. New and tighter credit requirements are holding back a housing sector recovery, she says, and it's time for lenders to dump tougher loan standards so we can get real estate back on track.
This is an important matter. We want more buyers and one way to get them is to lower application barriers. More buyers translate into a larger pool of potential purchasers, more demand and thus more pressure to raise home prices. That's attractive because an increased number of purchasers will help us sweep up the huge inventory of distressed homes, short sales
, foreclosures and REOs which now clog the market. Reduced Lender Standards
What Duke suggests is that we have a general return to the lending practices which were in place before the foreclosure meltdown. But are such practices really attractive? Let's look at some specifics:
"Many households," says Duke, "are unable to purchase homes because of mortgage credit conditions, which are substantially tighter now than they were prior to the recession."
One reason we today have a recession is because of loose credit in the housing market. This happened because many lenders abandoned long-established credit standards. Instead you could easily get financing with a no-doc loan application, little or nothing down and small monthly payments made possible with the use of "nontraditional" loan products — payments so small they did not cover interest.
Such practices and products worked just fine as long as home prices continued to rise. Once appreciation ended borrowers with toxic loans were left with huge monthly payments that made properties difficult to hold and negative equity which made them impossible to sell. Tight Credit
"Some of this tightening is appropriate, as mortgage lending standards were lax, at best, in the years before the peak in house prices. However, the extraordinarily tight standards that currently prevail reflect, in part, new obstacles that inhibit lending even to creditworthy borrowers," according to Governor Duke.
According to the National Association of Realtors
4.26 million existing homes were sold in 2011. That's a huge number given high levels of unemployment and tells us a lot of people easily get loans. Underwriting
Duke argues that "these tight standards can take many forms, including stricter underwriting, higher fees and interest rates, more stringent documentation requirements, larger required down payments, stricter appraisal standards, and fewer available mortgage products."
Huh? How is it possible to say that interest rates are higher?
According to Freddie Mac
, as mid-January "the 30-year fixed-rate mortgage edged down slightly to 3.88 percent to a new all-time record low marking the seventh consecutive week below 4.00 percent."
In fact, there's a huge case for stricter underwriting — that's how lenders and mortgage investors avoid losses.
Lenders should want more stringent documentation requirements — if tougher underwriting requirements had earlier been in place we would not see the endless number of lawsuits against loan originators and servicers that are now in the courts.
Down payment demands have hardly moved -- the FHA, for example, has gone from 3 percent to 3.5 percent down. It's still zero down at the VA and 5 percent down with conventional loans. High-risk loans now require 20 percent down but why is that wrong? Would bank shares now be so low if lenders had protected themselves by demanding big down payments for dicey loans?
There should be tougher appraisal standards otherwise lenders will make inflated loans that lead to more losses, drive away mortgage investors and undermine the lending system.
There's no lack of sensible loan products. FHA, VA and conventional mortgages are available everywhere. Credit
Ms. Duke brings up the issue of credit access and says we have less of it today.
"This tightening in mortgage credit," she says, "can be seen in the increase in the credit scores associated with newly originated prime and Federal Housing Administration (FHA) mortgage originations, which suggests that borrowers who likely had access to mortgage credit a few years ago are now essentially excluded from the mortgage market."
Solid credit scores are precisely what everyone should want. Buyers with good credit scores are not frozen out of the market (look at the NAR sale figures) and as a matter of sound financial practice lenders should not be making loans to individuals with impaired credit.
There's some thinking — but a lot of differing on the details — which cautiously argues that today's credit standards are working.
Paul Krugman — a Nobel-prize winning economist and a columnist with the New York Times
— says "the economy is depressed, in large part, because of the housing bust, which immediately suggests the possibility of a virtuous circle: an improving economy leads to a surge in home purchases, which leads to more construction, which strengthens the economy further, and so on. And if you squint hard at recent data, it looks as if something like that may be starting: home sales are up, unemployment claims are down, and builders’ confidence is rising."
No less important, while the market today is weak consider where we've been — and where we could be.
Doug Duncan, the chief economist at Fannie Mae
, says in 2012 that "we expect the net effect will be a year of moderate growth edging away from the 2011 threat of a double dip.” Foreclosure Investments
To the extent traditional mortgage terms have returned foreclosure buyers benefit in two ways:
First, there are fewer purchasers and that means more rental demand.
Second, "traditional loan standards are associated with low foreclosure levels," said Daren Blomquist, a spokesman for RealtyTrac
. "Fewer foreclosures mean we can reduce the inventory of distressed homes over time and as a result have a better outlook for local real estate values."
There's no doubt that reduced lender standards are seductive, but there's also need for caution. If we once again make it "too easy" to get a mortgage we may also make it "too likely" that the foreclosure meltdown will continue — or grow even bigger.
Peter G. Miller is syndicated in newspapers nationwide and operates the consumer real estate site, OurBroker.com