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April 12th, 2013

When will mortgage lending standards ease?

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The post below first appeared on U.S. News & World Report’s Home Front blog on Nov. 20. A special thanks to Meg Handley and the entire Home Front team:

rejectedAlmost five years after banks – burned by bad mortgages and the imploding housing market – clammed up on credit, lending conditions still remain tight, stunting further improvement in the housing market.

So when does it end? When do banks finally start lending gain?

A lot of the current credit issues have to do with the deluge of refinancing lenders have been hit with thanks to historically low interest rates.

“When refinancing demand is high, lenders have less incentive to pursue harder-to-complete or less profitable loan applications,” Federal Reserve Gov. Elizabeth Duke said in a recent speech to the Mortgage Bankers Association. “In the current environment, refinance applications by high-credit-quality borrowers are likely the easiest to complete.”

“It is possible that the abundance of these applications may have had the unintended effect of crowding out borrowers with lower credit scores, whose applications may be more time consuming to process,” Duke added.

Keith Gumbinger, vice president of mortgage information site HSH.com, agrees, saying there’s a direct correlation between today’s tight underwriting standards and a slack in purchase demand.

“If you were a lender, which loan would you pursue: an existing customer with a perfect payment history looking to refinance, or a young, first-time buyer with less than stellar credit?” Gumbinger says.

But once refinances dwindle to the point that originations slow, lenders will once again need to attract purchase customers, a large portion of which comprise first-time homebuyers. Lending conditions will certainly need to ease in order for that to happen since young, first-time buyers tend to have lower credit scores and student loan debt.

While certainly an increase in purchase activity will help ease standards, lending conditions won’t seriously change until three other changes take place:

1. Fannie and Freddie ease their standards: Since they make up such a large portion of the market, we won’t see widespread change until Fannie and Freddie decide to ease their standards. But that may be difficult, since tight standards mean more profitable loans, and more profitable loans mean paying back taxpayers for the $116 billion bailout more quickly.

2. Increased role for the private market: Increased participation by the private mortgage market means more competition for the same loans and even new and different loan products to choose from. Increased private market participation in the jumbo market has also led to cheaper borrowing costs on large loans.

3. Resolving uncertainties surrounding regulation: With portions of Dodd-Frank Wall Street Reform Act not even fleshed out and the upcoming implementation of the Qualified Residential Mortgage (QRM) definition, lenders are skeptical about what the future of the market will look like and how it will influence their ability to make money. A clearer picture on the new rules governing the mortgage industry would go a long way in making lenders more comfortable about writing new home loans.

So while there’s no one factor that will be responsible for easing lending conditions, pay attention to refinance applications and activity. A significant falloff in refinances and an upswing in purchase activity will likely signal looser conditions are starting to happen.

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2 Responses to “When will mortgage lending standards ease?”

  1. Steve Cook Says: April 16th, 2013 at 12:31 pm

    Tim:

    I dont think you have it quite right.

    Regarding Fannie and Freddie’s lending standards, I’m not sure they are the solution you claim. First, Fannie Mae’s charter established that any conventional single-family mortgage loan it purchases or securitizes that has a loan-to-value (LTV) ratio over 80%, which means any borrower making a down payment of less than 20% must have credit enhancement such as mortgage insurance. Since this standard has been in place for decades and wasn’t tightened in the wake of the flood of subprime foreclosures that drove Fannie into conservatorship, there’s not much point in altering it now.

    Fannie Mae requires a borrower to pledge at least 5% collateral to secure a loan; to have a debt-to-income ratio of 36% to 45% (depending on compensating factors); and to have a minimum credit score of 660 for loans with an LTV above 75%, according to FHFA inspector general last year.

    These standards are far looser than current practice. The median down payment today is 9 percent, including FHA, and the median front end DTI in February is 23% on all loans, 22% on conventional purchase loans. Median credit score on an approved conventional purchase loan is 761 and the median score of rejected purchase applications is 731—way above Fannie’s 660—according to Ellie Mae’s February Origination Insights Report.

    No, pointing fingers at the GSEs doesn’t wash. I’m certainly not their advocate, and goodness knows Fannie’s archaic 80% LTV rule did more to create the private mortgage insurance business than it did to protect Fannie’s portfolio from getting whacked, but I would respectfully submit the answer lies elsewhere, particularly your point number two.

    Just wait til rates rise, the refi business shrivels, and tens of thousands of loan officers are looking for work. Then watch aggressive lenders who are ready for the purchase mortgage business drive the competition into the ground.

    Steve Cook
    Co-publisher and Editor
    Real Estate Economy Watch

  2. Vacation-home sales are heating up | Quizzle.com Blog Says: April 22nd, 2013 at 12:52 pm

    [...] When will mortgage lending standards ease? [...]

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About the HSH Blog

HSH.com's daily blog focuses on the latest developments in the mortgage and housing markets. Our mission is to relate how changes in mortgage rates and housing policy, as well as the latest financial news, impacts consumers, homebuyers and industry insiders alike. Our 30-plus years of experience in the mortgage industry gives us an edge as we break down the latest changes in an ever-changing market.

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Tim Manni

Tim Manni is the Managing Editor of HSH.com and the author of their daily blog, which concentrates on the latest developments in the mortgage and housing markets.

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