Getting a mortgage is far more difficult than it should be. This is hurting the housing recovery, which is vital to creating more and better jobs.
Housing regulators recognize the problem and have announced steps to ease the barriers to getting a loan. Some fear this means we are inexorably headed down the same disastrous path of bad lending that resulted in the financial crisis and Great Recession. Those fears are misplaced, at least for now.
By any historical standard, it is tough to get a mortgage. Potential first-time home buyers and lower- and middle-income households have an especially difficult time, but even Ben Bernanke has had trouble refinancing his mortgage since leaving his job as Federal Reserve chairman. There are many reasons U.S. home buying remains anemic, but tight mortgage credit is at the top of the list.
One significant barrier to qualifying for a loan is the down payment. The regulator of mortgage giants Fannie Mae and Freddie Mac (which purchase more than half of all the mortgages made in the United States) has said that under certain circumstances they can reduce their minimum required down payments from 5 percent of the purchase price to 3 percent. For the average home purchase, this would lower the required down payment by about $4,000.
This is a big deal. It would make buying homes possible for millions of renting households who can afford monthly mortgage payments but don’t have enough for down payments.
A reasonable concern is that more of these households will ultimately default on their mortgages. All else being equal, a borrower with less skin in the game will be more likely to send their house keys back to a lender.
But not all things are equal. To offset the risk of making a low-down-payment loan, lenders could limit loan sizes so that borrowers devote a smaller percentage of their income to debt service. Lenders could also require borrowers to have a higher credit scores. They could even direct borrowers into 20-year mortgages, to build equity more quickly than they would in the more common 30-year mortgage.
Moreover, even 3 percent down is a lot for lower-income households, creating a significant incentive to make their payments on time.
Another barrier to obtaining mortgages is the credit score. Before the housing bubble and bust, the average mortgage borrower had a score of close to 700. The average borrower today is has a score closer to 740. This may not sound like a large difference, but it is. More than 10 million renters have the financial wherewithal to become homeowners but cannot because of the extraordinarily high scores required by lenders.
Lenders have been arguing that a principal reason they require such high scores has to do with the policies of Fannie Mae and Freddie Mac. When Fannie and Freddie buy loans, they require the originating lenders to provide a warranty that the loans were made to their standards. If it is later determined that lenders erred in making those loans, lenders are required to buy them back. Because this generally happens when a loan is in trouble, such lenders lose lots of money.
There is no doubt that lenders made lots of loans they shouldn’t have during the housing bubble, and they have paid dearly. So-called buybacks on these loans have totaled more than $125 billion since the housing bust.
Yet a lot of gray area surrounds lender mistakes. It thus seems reasonable for lenders to want more black and white in the warranties they provide to Fannie Mae and Freddie Mac. Some progress has been made on this, and Fannie and Freddie’s regulator says more is on the way.
Any time lending standards decline it is appropriate to question whether the standards are too low. No one did so when the housing bubble was inflating, and taxpayers paid dearly for this. When all is said and done, losses on defaulted mortgage loans made during that time will approach $1 trillion.
Will lending standards under the new rules be too low? No. Even if lenders make loans with 3 percent down payments, or based on credit scores typical of the average American, there is no sign that we are headed back to bubble-era home lending.
Loans made today are vanilla, 30-year, fixed-rate loans, and not the subprime, no-documentation, negative-amortization loans that blew up in the bust. Fudging the value of the home is much harder as is getting a loan to speculate and flip homes. Lenders must also hold a lot more capital as a financial cushion in case loans default, when they make loans to less-creditworthy borrowers.
To be sure, if history is a guide, lending standards will continue to fall and may eventually become too low. Regulators then will need to respond. Allowing low-down-payment loans or loans to borrowers with lower credit scores shouldn’t be written in stone. A time may come when the risks they pose to borrowers and taxpayers are too high. But that time is a long way off.
Mark Zandi is chief economist at Moody’s Analytics, a subsidiary of Moody’s Corp. He is the author of “Paying the Price,” an assessment of monetary and fiscal policy in the wake of the recession, and “Financial Shock,” a book about the financial crisis. His columns appear occasionally in The Washington Post.