Credit standards that consumers must meet to get a mortgage are expected to stiffen over the next few months as mortgage lenders act to shore up the reputation of the American home mortgage in national and international capital markets.
For the past several years, securities backed by mortgages have sold well in capital markets, making mortgage money readily available for home buyers. Lenders also have been willing to write loans with discounted starting interest rates and other devices to make mortgages affordable to a broad sector of the public.
Some of those mortgages, however, are proving to have been too soft in their requirements. Delinquencies on mortgage payments and foreclosures are running at near record levels in many sections of the country and lenders are concerned that investors may look for other places to put their money.
"In the past month, the real estate finance industry has recognized the evolving need for tighter mortgage-loan underwriting standards," said Thomas M. French Jr., director of mortgage banking for the Jacksonville, Fla., office of the Bank of Boston. "Today's lower inflation environment has spurred the need for closer scrutiny of underwriting, particularly in light of relatively high delinquency and foreclosure rates."
Lenders acknowledge that, during recent periods of high inflation, they were more willing to write loans for people who might be credit risks because rising housing values would cut the amount of time that the lender was exposed to a risky loan. If the value of the house increased by 10 percent during the first year of the loan, the lender could easily recoup losses if the mortgage went to foreclosure.
Foreclosures are up now, industry experts say, because home values have not risen as quickly in the past two years as they did during the previous seven years.
The development of the secondary-mortgage market has made it easy for investors to put their money into mortgages by purchasing securities backed by pools of mortgages. The secondary-mortgage-market conduits -- those companies that purchase the loans from lenders and package the mortgages as securities -- have helped lenders by making money available for new loans during the past several years.
The fear, according to mortgage bankers attending this week's Mortgage Bankers Association of America's annual convention here, is that a few problems in the industry that have led to high delinquency rates on certain types of loans could trigger a loss of confidence in the American mortgage and cause investors to try other types of investments.
If that happened, the lenders say, mortgage money could become scarce and loans harder to come by, which could drive mortgage interest rates up. The Federal National Mortgage Association, the secondary-mortgage-market conduit known as Fannie Mae, tightened its credit standards in August, saying that it no longer would buy loans that did not meet certain requirements. While Fannie Mae only purchases about 10 percent of the loans made, most lenders now say they are adopting similar credit standards of their own, as the entire mortgage industry moves to forestall further losses.
French told mortgage bankers here that Fannie Mae's new guidelines, which require borrowers to have more income to qualify for the same loan than they have needed in the past, would have the same effect as raising mortgage interest rates by 2 percentage points.
That means, he said, that even if mortgage interest rates stay stable, as expected over the next 12 months, the higher income requirements will shut as many people out of the housing market as would a 2-percentage-point rise in interest rates.
Industry experts say that consumers can expect to see increased standardization of mortgages, a reversal of the trend over the past four years that has brought consumers a bewildering proliferation of mortgages from which to choose.
Experts also say they expect investors to be more concerned about the relative risk of the mortgages that are collateral for mortgage-backed securities.
"It is clear that the mortgage market has been flooded with a variety of instruments, a variety of [lenders] and a variety of investment mechanisms," said Alan Hainey, senior vice president of General Electric Mortgage Securities Corp. "While I am not forecasting a return to one [type of mortgage] as the dominant vehicle, I am confident that a significant effort will be made by investors to pay more attention" to the credit standards of the mortgages behind the mortgage-backed securities, he said.
In the past, Hainey said, investors have been concerned primarily with the investment yields and prices of such mortgage-backed securities, but now they are becoming more interested in whether the loans have sufficient equity and are not overvalued in relation to the values of the houses that are collateral for the mortgages.
Officials with the Federal Home Loan Mortgage Corp., another secondary-mortgage-market conduit known as Freddie Mac, said they are evaluating credit standards and may soon announce changes in the types of loans they will accept.
"Credit risk management has become a major concern for Freddie Mac," said William R. Thomas Jr., the institution's executive vice president for operations. "We are going to continue to review our underwriting and credit risk controls."
Mortgage bankers here said they will require borrowers to have higher incomes to get a loan and they may disallow adjustable-rate mortgages for home purchases where the borrower has put down only a small percentage of the home's price.