Tag Archives: 80% LTV

Mortgage Insurers and The Next Housing Crisis

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photo by Jeff Turner

The Inspector General of the Federal Housing Finance Agency has released a white paper on Enterprise Counterparties: Mortgage Insurers. The Executive Summary reads,

Fannie Mae and Freddie Mac (the Enterprises) operate under congressional charters to provide liquidity, stability, and affordability to the mortgage market. Those charters, which have been amended from time to time, authorize the Enterprises to purchase residential mortgages and codify an affirmative obligation to facilitate the financing of affordable housing for low- and moderate-income families. Pursuant to their charters, the Enterprises may purchase single-family residential mortgages with loan-to-value (LTV) ratios above 80%, provided that these mortgages are supported by one of several credit enhancements identified in their charters. A credit enhancement is a method or tool to reduce the risk of extending credit to a borrower; mortgage insurance is one such method. Since 1957, private mortgage insurers have assumed an ever-increasing role in providing credit enhancements and they now insure “the vast majority of loans over 80% LTV purchased by the” Enterprises. In congressional testimony in 2015, Director Watt emphasized that mortgage insurance is critical to the Enterprises’ efforts to provide increased housing access for lower-wealth borrowers through 97% LTV loans.

During the financial crisis, some mortgage insurers faced severe financial difficulties due to the precipitous drop in housing prices and increased defaults that required the insurers to pay more claims. State regulators placed three mortgage insurers into “run-off,” prohibiting them from writing new insurance, but allowing them to continue collecting renewal premiums and processing claims on existing business. Some mortgage insurers rescinded coverage on more loans, canceling the policies and returning the premiums.  Currently, the mortgage insurance industry consists of six private mortgage insurers.

In our 2017 Audit and Evaluation Plan, we identified the four areas that we believe pose the most significant risks to FHFA and the entities it supervises. One of those four areas is counterparty risk – the risk created by persons or entities that provide services to Fannie Mae or Freddie Mac. According to FHFA, mortgage insurers represent the largest counterparty exposure for the Enterprises. The Enterprises acknowledge that, although the financial condition of their mortgage insurer counterparties approved to write new business has improved in recent years, the risk remains that some of them may fail to fully meet their obligations. While recent financial and operational requirements may enhance the resiliency of mortgage insurers, other industry features and emerging trends point to continuing risk.

We undertook this white paper to understand and explain the current and emerging risks associated with private mortgage insurers that insure loan payments on single-family mortgages with LTVs greater than 80% purchased by the Enterprises. (2)

It is a truism that the next crisis won’t look like the last one. It is worth heeding the Inspector General’s warning about the

risks from private mortgage insurance as a credit enhancement, including increasing volume, high concentrations, an inability by the Enterprises to manage concentration risk, mortgage insurers with credit ratings below the Enterprises’ historic requirements and investment grade, the challenges inherent in a monoline business and the cyclic housing market, and remaining unpaid mortgage insurer deferred obligations. (13)

One could easily imagine a taxpayer bailout of Fannie and Freddie driven by the insolvency of the some or all of the six private mortgage insurers that do business with them. Let’s hope that the FHFA addresses that risk now, while the mortgage market is still healthy.

Can I Refinance?

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photo by GotCredit.com

LendingTree quoted me in Can I Refinance? Refinance Requirements for Your Mortgage. It opens,

While there are many reasons to refinance a mortgage, one of the biggest factors at play is whether or not you’ll be able to get a better interest rate. When interest rates drop, homeowners are incentivized to refinance into a new mortgage with a lower rate and better terms because it can potentially save them a boatload of money over the course of their loan.

Not only can refinancing save money on interest payments, but it can lead to lower monthly payments, or be a way to get rid of a pesky primary mortgage insurance requirement once you’ve earned enough equity in your home. Homeowners can also tinker with their repayment timeline when they refinance, choosing to lengthen their loan term or even shorten it to pay off their home faster.

The first question before you refinance your mortgage is simple: Does it make financial sense? Refinancing a mortgage comes with the same closing costs and fees as a regular mortgage, so you must stand to earn more by refinancing than you’ll pay to do it.

If you’ve had the same mortgage rate since the aughts or earlier, chances are you could have much to gain by refinancing in today’s lower rate environment.

The average interest rate on a 30-year, fixed-rate mortgage hit a low point of 3.31% on Nov. 21, 2012 and hasn’t budged all too much since then. Rates currently stand at 4.32% as of Feb. 8, 2018. By comparison, rates were routinely in the double digits in the 80s and early 90s.

Will rates continue on the upward trend? Unfortunately, nobody knows. But rate behavior will very likely play a key role in your decision.

Once you’ve decided refinancing makes financial sense, the next question should be this: What does it take to qualify? That’s what we’ll cover in this guide.

If you hope to refinance before rates climb any further, it’s smart to get your ducks in a row and find out the refinance requirements for your mortgage right away. Keep reading to learn the minimum requirements to refinance your mortgage, how your credit score may come into play and what steps to take next.

Can you refinance your home?

Lenders consider three main criteria when approving consumers for a home refinance – income, equity, and credit.

  • Debt and income.
  • Equity. Equity is important because lenders want to confirm possibly getting their money back out of your home if you default on your mortgage.
  • Credit. Any lending situation will involve a credit check. “They look at your credit score to see if you have the willingness to pay your mortgage back – to see if you’re creditworthy,” said David Reiss, Professor of Real Estate Law at The Center for Urban Business Entrepreneurship at Brooklyn Law School. “Do you have a low credit score or a high credit score? Do you pay your bills on time?” he asked. “These are all things your lender needs to know.”

While the above factors play a role in whether you’ll qualify to refinance your home, lenders do get fairly specific when it comes to how they gauge your income to determine affordability. Since the amount of income you need to qualify for a new mortgage depends on the amount you wish to borrow, lenders typically use something called “debt-to-income ratio” to measure your ability to repay, says Reiss.

Your debt-to-income ratio (DTI)

During the underwriting process for a conventional loan, lenders will look at all the factors that make them comfortable extending you a loan. This includes your income and your debt levels, says Reiss. “Debt-to-income ratio is an easy way for lenders to determine if you have too many debt payments that might interfere with your home mortgage payment in the future.”

To come up with a debt-to-income ratio, lenders look at your debts and compare them with your income.

But, how is your debt-to-income ratio determined? Your debt-to-income ratio is all of your monthly debt payments divided by your gross monthly income.

In the real world, someone’s debt-to-income ratio would work something like this:

Imagine one of your neighbors has a gross monthly income of $4,000, but they pay out $3,000 per month toward rent payments, car loans, child support, and student loans. Their debt income ratio would be 75% because $3,000 divided by $4,000 is .75.

Reiss says this factor is important because lenders shy away from consumers with debt-to-income ratios that are considered “too high.” Generally speaking, lenders prefer to loan money to borrowers with a debt-to-income ratio of less than 43% but 36% is ideal.

In the example above where your neighbor has a monthly gross income of $4,000, this means he or she may have to get all debt payments down to approximately $1,700 to qualify for a mortgage. ($1,700 divided by $4,000 = .425 or 42.5%).

There are exceptions to the 43% DTI rule, according to the Consumer Financial Protection Bureau. Some lenders may offer you a mortgage if your debt-to-income ratio is higher than 43%. Situations, where such mortgages are offered, include when a borrower has a high credit score, a stellar record of repayment or both. Still, the 43% rule is a good rule of thumb to follow when it comes to traditional mortgages.

Other financial thresholds

If you plan to refinance your home with an FHA mortgage, your housing costs typically need to be less than 29% of your income while your total debts should be no more than 41%.

However, the U.S. Department of Housing and Urban Development, which oversees FHA loans, also notes that potential borrowers with lower credit scores and higher debt-to-income ratios may need to have their loans manually underwritten to ensure “adequate consideration of the borrower’s ability to repay while preserving access to credit for otherwise underserved borrowers.”

Mortgage broker Mark Lewin of Caliber Home Loans in Indiana even says that in his experience, individuals with good credit and “other compensating factors” have secured FHA loans with a total debt-to-income ratio of 55%.

Of course, those who already have an FHA loan may also be able to refinance to a lower rate with no credit check or income verification through a process called FHA Streamline Refinancing. Your debt-to-income ratio won’t even be considered.

A VA loan is another type of home loan that has its own set of debt-to-income requirements. Generally speaking, veterans who meet eligibility requirements for the program need to have a debt-to-income ratio at or below 41% to qualify. However, you may be able to refinance your home with an Interest Rate Reduction Refinance Loan from the VA if you already have a VA loan. These loans don’t have any underwriting or appraisal requirements.

Equity requirements

Equity requirements to refinance your mortgage are typically at the sole discretion of your lender. Where some home mortgage companies may require 20% equity to refinance, others have much lighter requirements.

To find out what your home is worth and how much equity you have, you typically need to pay for a home appraisal, says Reiss. “Appraisals are typically required because you have to be able to prove the value of your home in order to refinance, just like you would with a traditional mortgage.”

There are a few exceptions, however. Mortgage refinancing options that may not require an appraisal include:

  • Interest Rate Reduction Refinance Loans from the VA
  • FHA Streamline Refinance
  • HARP (Home Affordable Refinance Program) Mortgages

Explaining loan-to-value ratio, or LTV

Loan-to-value ratio is a figure determined by assessing how much you owe on your home in relation to its value. If you owe $80,000 on a home worth $100,000, for example, your LTV would be 80% and you would have 20% equity in your home.

This ratio is important because it can determine whether your lender will approve you for a refinance. It can also determine the interest rates you’ll pay and other terms of your loan. If you have less than 20% equity in your home, for example, you may face higher interest rates and fees when you go to refinance.

Having less than 20% equity when you refinance may also cause you to have to pay PMI or private mortgage insurance. This mortgage insurance usually costs between 0.15 to 1.95% of your loan amount each year. If you have less than 20% equity in your home already, you’re already likely to be paying for this coverage all along. However, it’s still worth noting that, if you refinance with less than 20% equity, this coverage will once again get tacked onto your mortgage amount.

Is 80% LTV mandatory?

Your LTV and equity aren’t the end-all, be-all when it comes to your loan refi application. In fact, Reiss says that lenders he has experience with don’t absolutely require borrowers to have 20% equity or a loan-to-value ratio of 80% — so long as they score high on other measures.

“If you meet the lender’s requirements in terms of income and credit, your loan-to-value ratio doesn’t matter as much — especially if you have excellent credit and a solid payment history,” he said. However, lenders do prefer lending to consumers who have at least 20% equity in their homes.

Reiss says he always refers to 20% equity as the “gold standard” because it’s a goal everyone should shoot for. Not only does having 20% equity in your home when you refinance help you avoid paying for the added expense of PMI, but it can help provide more stability in your life, says Reiss: “Divorce, disease, and death in the family can and do happen, but having equity in your home makes it easier to overcome anything life throws your way.”

For example, having more equity in your home makes it easier to refinance into the best rates possible. Having a lot of equity is also ideal when you have to sell your home suddenly because it means you’re more likely to turn a profit and less likely to take a loss. Last but not least, if you have plenty of equity in your home, you can access that cash for emergency expenses via a home equity loan or HELOC.

“Home equity is a big source of wealth for American families,” he said. “The more equity you have, the more resources you have.”

Fortunately, many households are enjoying greater home equity today, as home values have continued to increase since the housing crisis.

Your credit score

The third factor that can impact your ability to refinance your home is your credit score. When a lender decides whether to give you a mortgage or not, they typically offer the best rates to people with very good credit, or with FICO scores of 740 or higher, according to Reiss.

“The lower your credit score, the higher your interest rate may be,” he said. “If your credit score is bad enough, you may not be able to refinance or get a new mortgage at all.”

The FICO scoring model’s main website, myFICO.com, seems to echo Reiss’ comments. As it notes, a “very good” score is any FICO score in the 740-799 range. If you earn a 740+ FICO, you’re above the national average and have a greater likelihood of getting credit approval and being offered lower interest rates.

Don’t stress about getting a perfect 850 FICO score either. In reality, rates stop improving much once you pass 740.

Top Ten Issues for Housing Finance Reform

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Laurie Goodman of the Urban Institute has posted A Realistic Assessment of Housing Finance Reform. This paper is quite helpful, given the incredible complexity of the topic. The paper includes a lot of background, but I assume that readers of this blog are familiar with that.  Rather, let me share her Top Ten Design Issues:

  1. What form will the private capital that absorbs the first loss take: A single guarantor (a utility), multiple guarantors, or multiple guarantors along with capital markets execution? How much capital will be required?
  2. Who will play what role in the system? Will the same entity be permitted to be an originator, aggregator, and guarantor?
  3. How will the system ensure that historically underserved borrowers and communities are well served? To what extent will the pricing be cross subsidized?
  4. Who will have access to the new government-backed system (loan limits)? How big should the credit box be, and how does that box relate to FHA?
  5. Will mortgage insurance be separate from the guarantor function? (It is separate under most proposals, but in reality both sets of institutions are guaranteeing credit risk. The separation is a relic of the present system, in which, by charter, the GSEs can’t take the first loss on any mortgage above 80 LTV. However, if you allow the mortgage insurers and the guarantors to be the same entity, capital requirements must be higher to adequately protect the government and, ultimately, the taxpayers.)
  6. How will small lenders access the system? (All proposals attempt to ensure access, some through an aggregator dedicated to smaller lenders—a role that the Home Loan Banks can play.)
  7. What countercyclical features should be included? If the insurance costs provided by the guarantors are “too high” should the regulatory authority be able to adjust capital levels down to bring down mortgage rates? Should the regulatory authority be able to step in as an insurance provider?
  8. Will multifamily finance be included? How will that system be designed? Will it be separate from the single-family business? (The multifamily features embedded in Johnson-Crapo had widespread bipartisan support, but the level of support for a stand-alone multifamily legislation is unclear.)
  9. The regulatory structure for any new system is inevitably complex. Who charters new guarantors? What are the approval standards? Who does the stress tests? How does the new regulator interact with existing regulators? What enforcement authority will it have concerning equal access goals? What is the extent of data collection and publication?
  10. What does the transition look like? How do we move from a duopoly to more guarantors? Will Fannie and Freddie turn back to private entities and operate as guarantors alongside the new entrants? How will the new entities be seeded? What is the “right” number of guarantors, and how do we achieve that? How quickly does the catastrophic insurance fund build? (16-17)

None of this is new, but it is nice to see it all in one place. These design issues need to thought about in the context of the politics of housing reform as well — what system is likely to maintain its long-term financial health and stay true to its mission, given the political realities of Washington, D.C.?

Speaking of politics, her prognosis for reform in the near term is not too hopeful:

The current state of the GSEs can best be summed up in a single word: limbo. Despite the fact that Fannie Mae and Freddie Mac were placed in conservatorship in 2008, with the clear intent that they not emerge, there is little progress on a new system, with a large role for private capital, to take their place. Legislators have realized it is easy to agree on a set of principles for a new system but much harder to agree on the system’s design. It is unclear whether any legislation will emerge from Congress before the 2016 election; there is a good chance there will be none. (26)

She does allow that the FHFA can administratively move housing finance reform forward to some extent on its own, but she rightly notes that reform is really the responsibility of Congress. Like Goodman, I am not too hopeful that Congress will act in the near term. But it is crystal clear that there is a cost of doing nothing. In all likelihood, it will be the taxpayer will pay that cost, one way or another.

Risky Cash-Out Refis

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Anil Kumar of the Dallas Fed has posted Do Restrictions on Home Equity Extraction Contribute to Lower Mortgage Defaults? Evidence from a Policy Discontinuity at the Texas’ Border to SSRN.  The abstract reads

Given that excessive borrowing helped precipitate the housing crisis, a key component of a policy agenda to prevent future meltdowns is effective regulation to curb unaffordable mortgage debt. Texas is the only US state that limits home equity borrowing to 80 percent of home value. Anecdotal reports have long suggested that home equity restrictions shielded Texas homeowners from the worst of the subprime mortgage crisis. But there is, as yet, no formal empirical investigation of these restrictions’ role in curbing mortgage default. This paper is the first to empirically estimate the impact of Texas home equity restrictions on mortgage default using individual and loan level data from three different sources. The paper exploits the policy discontinuity around Texas’ interstate borders induced by the home equity restrictions to identify the causal effect of home equity extraction on mortgage default in a border discontinuity design framework. The paper finds that limits on home equity borrowing in Texas lowered the likelihood of mortgage default by about 2 percentage points with a significantly larger impact on mortgage borrowers in the bottom quartile of the credit score distribution. Estimated default hazards for mortgages within 50 to 100 miles of the Texas’ border decline sharply as one crosses into Texas. Overall, the paper finds evidence that Texas’ home equity restrictions exert a robust negative impact on mortgage default.

This is a really important paper asking a really important question.  If its findings are confirmed, it brings us back to that age-old question of paternalism in consumer financial protection: should we limit a consumer’s choice if that choice is consistently shown to have harmful effects?  I am not sure where I come down in this particular case, but I wonder if some version of Quercia et al.‘s benefit ratio could help measure the costs and benefits of such a rule. The benefit ratio compares “the percent reduction in the number of defaults to the percent reduction in the number of borrowers who would have access to [a certain type of] mortgages.” (20) I am not sure whether access to cash out refi mortgages is of the same import as purchase mortgages or even plain old refis, but the concept of the benefit ratio might still make sense in this context.