Credit risk has reemerged recently as the primary concern for mortgage lenders and is expected to contribute to a continued depression of housing starts over the next few quarters and possibly even to an upturn in mortgage interest rates.
Industry representatives say the risk that a borrower might not be able to meet mortgage payments and will default on a loan, and the related problem of keeping housing affordable if lenders are going to tighten credit standards, has been the "burning issue" inside housing circles for the past few months, threatening to split the major factions of the housing industry.
Mortgage lenders, private mortgage insurance companies and companies active in the secondary mortgage market have pushed for tougher loan standards in an effort to keep investors from shying away from mortgage-backed securities. On the other side are the real estate brokers and home builders, who have fought to keep housing affordable during a time of historically high interest rates.
Credit risk was the primary concern of mortgage lenders during the first 50 years of the amortized mortgage, from roughly 1930 to the late 1970s. Interest rates were low and, because appreciation of housing values moved at a snail's pace, equity in the property built up slowly.
In the 1970s, however, when high inflation pushed housing values through the roof, appreciation reduced lenders' risks substantially. If a lender made a loan to someone who might not be able to pay it back, or who might have to spend a large part of his or her income on the mortgage, the risk of the lender losing money receded as the value of the house rose.
At the same time, rising prices made housing less affordable and, in an effort to keep people buying houses, lenders were willing to lower loan standards. Mortgage loans, traditionally made at double a borrower's income, swelled to three times a borrower's income.
Then, when interest rates rose in the late 1970s, many lenders got caught with large numbers of loans earning less than their cost of borrowing more money, and they were eager to write new loans at higher rates to offset the deficit. To counter high interest rates, lenders began pushing adjustable-rate mortgages with low starting rates and graduated-payment mortgages to make housing affordable to buyers with modest incomes.
As inflation has dropped in the past few years, however, homeowners and lenders alike have found that appreciation will not bail them out of a bad loan, and record numbers of people are facing foreclosure. The national foreclosure rate is at a near-record high of 0.24 percent, second only to a rate of 0.25 percent in 1973 and 1974 and again in the third quarter of last year.
In a study on the future of private mortgage insurance conducted this spring, Moody's Investors Service found that home prices appreciated by 2.8 percent in 1982 and 3.2 percent in 1982 and 1983 and an estimated 4 percent for 1984, down sharply from the 10.9 percent average annual appreciation during the 1970s.
Responding to a record-high foreclosure rate, the Federal National Mortgage Association announced last month that it will tighten the requirements prospective buyers must meet to qualify for a home loan. The association, known as Fannie Mae, buys mortgages from banks and savings and loans, providing the lenders with money to make additional loans. The company then packages the mortgages and sells securities backed by them on the secondary market.
The restrictions will require buyers who put down less than 10 percent of the purchase price to have more income to get loans than they needed in the past. Fannie Mae also put new restrictions on the types of adjustable-rate mortgages it would buy.
"In order to keep the housing market going, Fannie Mae took the lead during the recession in making a market in mortgage products that would enable more people to afford homes," said David Maxwell, chairman and chief executive officer of Fannie Mae. "Perhaps some of those people should not have bought homes."
Because many lenders sell their home loans to Fannie Mae, savings and loans and banks are expected to incorporate the new restrictions into their own lending practices. Some private mortgage insurers have imposed similar restrictions, and others are expected to follow suit soon.
"We are all having to learn to live with the new pace of housing appreciation," said Weston Edwards, senior executive vice president of Lomas & Nettleton, one of the country's largest mortgage banking companies. "With many of these loans, the borrowers have almost no equity in the property. If there are any problems -- if they get laid off or something -- they just stop paying their mortgage. Since they have very little money in the place, they have little to lose."
Low-equity mortgages -- those for which the borrower has put down 5 percent of the purchase price or less or those in which the builder has offered to buy down the cost of the loan, thereby inflating the cost of the house above its market value -- are seen by some segments of the industry as a time bomb that could go off if the country experienced another recession similar to that of the early 1980s.
Moody's study found that private mortgage insurers had loss ratios higher than 100 percent during 1982 and 1983, meaning that they were paying more out in claims than they were taking in in premiums on new mortgages. Before that, peak loss ratios had reached only 38 percent, Moody's said. The losses peaked in 1983 at 116 percent.
Real estate brokers and home builders, however, would like to preserve the 95 percent mortgage and other builder options such as buydowns as a way of keeping housing affordable for first-time buyers.
"The biggest fight in the housing industry this year is whether or not to keep the 95 percent loan," said one industry executive, who spoke on condition that his name not be used. "We don't have many major disagreements in this industry, but this is one."
While some lenders praised Fannie Mae's action as a necessary step "in advance of serious loss of confidence in the American home mortgage," the National Association of Realtors and the National Association of Home Builders questioned whether the move actually would address the root problems of Fannie Mae's record-high foreclosure losses.
According to David Seiders, senior staff vice president for housing policy and mortgage finance with the Home Builders, the concern is that, by increasing the income requirement for people putting less than 10 percent down on a house, Fannie Mae has made buying a home more difficult for first-time buyers without really addressing the problem of increasing equity.
"The economic incentive to default on a mortgage has actually been increasing over the past several years," Seiders said. "Back in the old days, the last thing a family would give up was the house, but now, with changes in the bankruptcy laws that . . . allow people to protect their other assets, we're finding that people with little equity are more willing to walk away from their loans."
Edwards said that some lenders have been talking about taking a "more aggressive" role in going after other assets people might have if they are left holding a property with a market value below the amount of the mortgage loan.
"Most mortgage loans are full-recourse loans, meaning a bank can try to recover losses by taking people's cars or other assets and while lenders have traditionally not gone after those other assets, that may be something they will need to do in the future," Edwards said.
Experts say the bottom line is that tightening credit standards eventually will push up requirements for down payments, will raise settlement costs because of increased private mortgage insurance requirements, and could push up mortgage interest rates if lenders believe there is more risk in mortgage lending then in the past.
The Home Builders and other experts say that concern over credit risk is a major factor in the surprisingly low rate of single-family homes started this summer, a period during which mortgage interest rates have been at their lowest level since 1980.
"We fear that Fannie Mae may have gone too far," Seiders said. "They would rather not make 95 percent mortgage loans and, as a result, we're going to be withdrawing from the part of the market with modest means."
Fannie Mae believes, however, that it has not cut 95 percent mortgages out of the market, only that buyers will have to "readjust" their buying patterns. It also said it believes that people should be able to save money for a down payment more easily today than they could several years ago when inflation kept housing prices rising as fast as the average family could save.
"Many of the people taking 95 percent loans could afford to put more money down," said Richard Daniel, Fannie Mae's senior vice president for regional activities. "We're returning to a buying environment similar to what we saw prior to the inflation of the late '70s . If people can't qualify for a 95 percent mortgage on the house they want, they will have to look at a smaller house."