In response, administration officials say they are working to get banks to lend to a wider range of borrowers by taking advantage of taxpayer-backed programs — including those offered by the Federal Housing Administration — that insure home loans against default.
Housing officials are urging the Justice Department to provide assurances to banks, which have become increasingly cautious, that they will not face legal or financial recriminations if they make loans to riskier borrowers who meet government standards but later default.
Officials are also encouraging lenders to use more subjective judgment in determining whether to offer a loan and are seeking to make it easier for people who owe more than their properties are worth to refinance at today’s low interest rates, among other steps.
Obama pledged in his State of the Union address to do more to make sure more Americans can enjoy the benefits of the housing recovery, but critics say encouraging banks to lend as broadly as the administration hopes will sow the seeds of another housing disaster and endanger taxpayer dollars.
“If that were to come to pass, that would open the floodgates to highly excessive risk and would send us right back on the same path we were just trying to recover from,” said Ed Pinto, a resident fellow at the American Enterprise Institute and former top executive at mortgage giant Fannie Mae.
Administration officials say they are looking only to allay unnecessary hesitation among banks and encourage safe lending to borrowers who have the financial wherewithal to pay.
“There’s always a tension that you have to take seriously between providing clarity and rules of the road and not giving any opportunity to restart the kind of irresponsible lending that we saw in the mid-2000s,” said a senior administration official who was not authorized to speak on the record.
The administration’s efforts come in the midst of a housing market that has been surging for the past year but that has been delivering most of the benefits to established homeowners with high credit scores or to investors who have been behind a significant number of new purchases.
“If you were going to tell people in low-income and moderate-income communities and communities of color there was a housing recovery, they would look at you as if you had two heads,” said John Taylor, president of the National Community Reinvestment Coalition, a nonprofit housing organization. “It is very difficult for people of low and moderate incomes to refinance or buy homes.”
Before the crisis, about 40 percent of home buyers were first-time purchasers. That’s down to 30 percent, according to the National Association of Realtors.
From 2007 through 2012, new-home purchases fell 30 percent for people with credit scores above 780 (out of 800), according to Federal Reserve Governor Elizabeth Duke. But they declined 90 percent for people with scores between 680 and 620 — historically a respectable range for a credit score.
“If the only people who can get a loan have near-perfect credit and are putting down 25 percent, you’re leaving out of the market an entire population of creditworthy folks, which constrains demand and slows the recovery,” said Jim Parrott, who until January was the senior adviser on housing for the White House’s National Economic Council.
One reason, according to policymakers, is that as young people move out of their parents’ homes and start their own households, they will be forced to rent rather than buy, meaning less construction and housing activity. Given housing’s role in building up a family’s wealth, that could have long-lasting consequences.
“I think the ability of newly formed households, which are more likely to have lower incomes or weaker credit scores, to access the mortgage market will make a big difference in the shape of the recovery,” Duke said last month. “Economic improvement will cause household formation to increase, but if credit is hard to get, these will be rental rather than owner-occupied households.”
Deciding which borrowers get loans might seem like something that should be left up to the private market. But since the financial crisis in 2008, the government has shaped most of the housing market, insuring between 80 percent and 90 percent of all new loans, according to the industry publication Inside Mortgage Finance. It has done so primarily through the Federal Housing Administration, which is part of the executive branch, and taxpayer-backed mortgage giants Fannie Mae and Freddie Mac, run by an independent regulator.
The FHA historically has been dedicated to making homeownership affordable for people of moderate means. Under FHA terms, a borrower can get a home loan with a credit score as low as 500 or a down payment as small as 3.5 percent. If borrowers with FHA loans default on their payments, taxpayers are on the line — a guarantee that should provide confidence to banks to lend.
But banks are largely rejecting the lower end of the scale, and the average credit score on FHA loans has stood at about 700. After years of intensifying investigations into wrongdoing in mortgage lending, banks are concerned that they will be held responsible if borrowers cannot pay. Under some circumstances, the FHA can retract its insurance or take other legal action to penalize banks when loans default.
“The financial risk of just one mistake has just become so high that lenders are playing it very, very safe, and many qualified borrowers are paying the price,” said David Stevens, Obama’s former FHA commissioner and now the chief executive of the Mortgage Bankers Association.
The FHA, in coordination with the White House, is working to develop new policies to make clear to banks that they will not lose their guarantees or face other legal action if loans that conform to the program’s standards later default. Officials hope the FHA’s actions will then spur Fannie and Freddie to do the same.
The effort requires sign-on by the Justice Department and the inspector general of Department of Housing and Urban Development, agencies that investigate wrongdoing in mortgage lending.
“We need to align as much as possible with IG and the DOJ moving forward,” FHA Commissioner Carol Galante said. The HUD inspector general and Justice Department declined to comment.
The effort to provide more certainty to banks is just one of several policies the administration is undertaking. The FHA is also urging lenders to take what officials call “compensating factors” into account and use more subjective judgment when deciding whether to make a loan — such as looking at a borrower’s overall savings.
“My view is that there are lots of creditworthy borrowers that are below 720 or 700 — all the way down the credit-score spectrum,” Galante said. “It’s important you look at the totality of that borrower’s ability to pay.”