Tag Archives: credit score

Caveat Rent-to-Own

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keys-1317391_1920WiseBread quoted me in 5 Things You Need to Know When Renting-to-Own a Home. It opens,

Your credit scores are too low. Or maybe you’ve run up too much credit card debt. Whatever the reason, you can’t qualify for the mortgage loan you need to buy a home. But there is hope: You can enter into a rent-to-own agreement and begin living in a home today — one that you might eventually be able to buy.

Just be careful: David Reiss, professor of law and research director for the Center for Urban Business at Brooklyn Law School, said that consumers need to be careful when entering rent-to-own arrangements. Often, these agreements end up with tenants losing money that they didn’t need to spend.

“Potential homebuyers should be very careful with rent-to-own opportunities,” Reiss said. “They have a long history of burning buyers. Does the law in your state provide any protection to a rent-to-own buyer who falls behind on payments? Could you end up losing everything that you had paid toward the purchase if you lose your job?”

These worries, and others, are why you need to do your research before signing a rent-to-own agreement. And it’s why you need to know these five key facts before agreeing to any rent-to-own contract.

1. How Do Monthly Rent and Final Selling Price Relate?

In a rent-to-own arrangement, you might pay a bit more in rent each month to the owner of a home. These extra dollars go toward reducing a final sales price for the home that you and the owner agree upon before you start renting.

Then, after a set number of years pass — usually anywhere from one to five — you’ll have the option to purchase the home, with the sales price lowered by however much extra money you paid along with your monthly rent checks. Not all companies that offer rent-to-own homes work this way. Some don’t ask for more money from tenants each month, and don’t apply any rental money toward lowering the eventual sales price of the home.

This latter option might be the better choice for you if you’re not certain that you’ll be able to qualify for a mortgage even after the rental period ends.

“A pitfall is if the tenant buyer signs into the program but will never be approved for financing, thus never purchases the house,” said John Matthews, president of operations of Chicago Lease to Own. “That is how the scammers out there have used rent-to-own to hurt people. They sell it to those who should never have been in the program and take their portion of the rent every month used ‘for the purchase of their home’ knowing that the tenant will never qualify to buy the home.”

Make sure you know — and are comfortable with — the home’s final sales price and monthly rent payments before you agree to a rent-to-own arrangement. And if you don’t want to pay extra in rent each month for a home that you might never end up buying? A rent-to-own agreement might not be for you.

Dems Favor Land Use Reform

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photo by DonkeyHotey

The Democratic Party has released its draft 2016 Policy Platform. Its housing platform follows in its entirety. I find the highlighted clause particularly intriguing and discuss it below.

Where Donald Trump rooted for the housing crisis, Democrats will continue to fight for those families who suffered the loss of their homes. We will help those who are working toward a path of financial stability and will put sustainable home ownership into the reach of more families. Democrats will also combat the affordable housing crisis and skyrocketing rents in many parts of the country that are leading too many families and workers to be pushed out of communities where they work.

We will increase the supply of affordable rental housing by expanding incentives and easing local barriers to building new affordable rental housing developments in areas of economic opportunity. We will substantially increase funding for the National Housing Trust Fund to construct, preserve, and rehabilitate millions of affordable housing rental units. Not only will this help address the affordable housing crisis, it will also create millions of good-paying jobs in the process. Democrats also believe that we should provide more federal resources to the people struggling most with unaffordable housing: low-income families, people with disabilities, veterans, and the elderly.

We will reinvigorate federal housing production programs, increase resources to repair public housing, and increase funding for the housing choice voucher program. And we will fight for sufficient funding to end chronic homelessness.

We must make sure that everyone has a fair shot at homeownership. We will lift up more families and keep the housing market robust and inclusive by defending and strengthening the Fair Housing Act. We will also support first time homebuyers, implement credit score reform to make the credit industry work for borrowers and not just lenders, and prevent predatory lending by defending the Consumer Financial Protection Bureau (CFPB). And we will help underwater homeowners by expanding foreclosure mitigation counseling. (4-5, emphasis added)

Much of the housing platform represents a continuation of Democratic policies, such as increased funding for affordable housing, improved enforcement of the Fair Housing Act and expanded access to counseling for distressed homeowners.

But the highlighted clause seems to represent a new direction for the Democratic Party: an acknowledgement that local land use decisions in areas of economic opportunity (read: the Northeast, the Bay Area and similar dynamic regions) are having a negative impact on low- and moderate-income households who are priced out of the housing markets because demand far outstrips supply.

This is a significant development in federal housing policy, flowing from work done by Edward Glaeser and Joseph Gyourko, among others, who have demonstrated the out-sized effect that the innumerable land use decisions made by local governments have had on the availability of affordable housing regionally and nationally.

There is a lot of ambiguity in the phrase “easing local barriers to building new affordable rental housing developments,” but the federal government has a lot of policy tools available to it to do just that. If Democrats are able to implement this aspect of the party platform, it could have a very positive impact on the prospects of households that are priced out of the regions where all the new jobs are being created.

Consumers’ Credit Score Score

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photo by www.gotcredit.com

The Consumer Federation of America and VantageScore Solutions, LLC, released the findings from their sixth annual credit score survey. Their findings are mixed, showing that many consumers have a basic understanding of how a credit score operates, but that many consumers are missing out on a lot of how they work. They find that

a large majority of consumers (over 80%) know the basic facts about credit scores:

  • Credit scores are used by mortgage lenders (88%) and credit card issuers (87%).
  • Key factors used to calculate credit scores are missed payments (91%), personal bankruptcy (86%), and high credit card balances (85%).
  • Ethnic origin is not used to calculate these scores (believed by only 12%).
  • 700 is a good credit score (81%).

Yet, the national survey also revealed that many consumers do not understand credit score details with important cost implications:

  • Most seriously, consumers greatly underestimate the cost of low credit scores. Only 22 percent know that a low score, compared to a high score, typically increases the cost of a $20,000, 60-month auto loan by more than $5,000.
  • A significant minority do not know that credit scores are used by non-creditors. Only about half (53%) know that electric utilities may use credit scores (for example, in determining the initial required deposit), while only about two-thirds know that these scores may be used by home insurers (66%), cell phone companies (68%), and landlords (70%).
  • Over two-fifths think that marital status (42%) and age (42%) are used in the calculation of credit scores. While these factors may influence the use of credit, how credit is used determines credit scores.
  • Only about half of consumers (51%) know when lenders are required to inform borrowers of their use of credit scores – after a mortgage application, when a consumer does not receive the best terms on a consumer loan, and whenever a consumer is turned down for a loan.

Overall, I guess this is good news although it also seems consistent with what we know about financial literacy — people are still lacking when it comes to understanding how consumer finance works. That being said, it would be great if we could come up with strategies to improve financial literacy so that people can improve their financial decision-making. I am not yet hopeful, though, that we can.

Mortgage Market Overview

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The Urban Institute’s Housing Finance Policy Center issued its May 2016 Housing Finance at a Glance Chartbook. This monthly report is invaluable for those of us who follow the mortgage market closely. The mortgage market changes so quickly and so much that what one thinks is the case is often no longer the case a few months later. This month’s report has new features, including Housing Credit Availability Index and first-time homebuyer share charts. Here are some of the key findings of the May report:

  • The Federal Reserve’s Flow of Funds report has consistently indicated an increasing total value of the housing market driven by growing household equity in each quarter of the past 2 years, and the trend continued according to the latest data, covering Q4 2015. Total debt and mortgages increased slightly to $9.99 trillion, while household equity increased to $13.19 trillion, bringing the total value of the housing market to $23.18 trillion. Agency MBS make up 58.2 percent of the total mortgage market, private-label securities make up 6.1 percent, and unsecuritized first liens at the GSEs, commercial banks, savings institutions, and credit unions make up 29.4 percent. Second liens comprise the remaining 6.4 percent of the total. (6)

It is worth wrapping your head around the size of this market. Total American wealth is about $88 trillion, so household equity of $13 trillion is about 15 percent of the total. With debt and mortgages at $10 trillion, the aggregate debt-to-equity ratio is nearly 45%.

  • As of March 2016, debt in the private-label securitization market totaled $613 billion and was split among prime (19.5 percent), Alt-A (42.2 percent), and subprime (38.3 percent) loans. (7)

This private-label securitization total is a pale shadow of the height of the market in 2007, back to the levels seen in 1999-2000. It is unclear when and how this market will recover — and the extent to which it should recover, given its past excesses

  • First lien originations in 2015 totaled approximately $1,735 billion. The share of portfolio originations was 30 percent, while the GSE share dropped to 46 percent from 47 in 2014, reflecting a small loss of market share to FHA due to the FHA premium cut. FHA/VA originations account for another 23 percent, and the private label originations account for 0.7 percent. (8)

The federal government, through Fannie Mae, Freddie Mac and Ginnie Mae, is insuring 69 percent of originations. Hard for me to think this is good for the mortgage market in the long term. There is no reason that the private sector could not take on a bigger share of the market in a responsible way.

  • Adjustable-rate mortgages (ARMs) accounted for as much as 27 percent of all new originations during the peak of the recent housing bubble in 2004 (top chart). They fell to a historic low of 1 percent in 2009, and then slowly grew to a high of 7.2 percent in May 2014. (9)

It is pretty extraordinary to see the extent to which ARMs change in popularity over time, although it makes a lot of sense. When interest rates are high and prices are high, more people prefer ARMs and when they are low they prefer FRMs.

  • Access to credit has become extremely tight, especially for borrowers with low FICO scores. The mean and median FICO scores on new originations have both drifted up about 40 and 42 points over the last decade. The 10th percentile of FICO scores, which represents the lower bound of creditworthiness needed to qualify for a mortgage, stood at 666 as of February 2016. Prior to the housing crisis, this threshold held steady in the low 600s. LTV levels at origination remain relatively high, averaging 85, which reflects the large number of FHA purchase originations. (14)

It is hard to pinpoint the right level of credit availability, particularly with reports of 1% down payment mortgage programs making the news recently. But it does seem like credit can be loosened some more without veering into bubble territory.

Hard to keep up with all of the changes in the mortgage market, but this chartbook sure does help.

Couples Leave Money on Closing Table

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photo by Dustin Moore

Geng Li, Weifeng Wu and Vincent Yao, three Fed economists, have posted a research note, Do People Leave Money on the Table? Evidence from Joint Mortgage Applications and the Minimum FICO Rule. The authors state that there “is mounting evidence that households make suboptimal savings and investment decisions” and find that

many mortgage borrowers appear to have failed to apply for mortgages that give the lowest interest rates. Specifically, we find that nearly 10 percent of prime borrowers who applied for their loans jointly could have lowered their mortgage interest rate at least one eighth of 1 percentage point if the mortgage was applied for by the applicant with a higher credit score and an income high enough to qualify for the mortgage. Furthermore, among the joint applicants with a lower credit score below 740, for whom mortgage interest rates are most sensitive to credit scores, more than 25 percent could have significantly reduced their borrowing cost by having the individual with a higher credit score apply. This is due to the fact that when lenders price mortgages with joint applications, the interest rates are determined by the lower score of the two–often known as the minimum FICO rule. We estimate that such borrowers could reduce their annual interest payment by between $220 and $1,400. Consistent with the existing literature, we find that couples who appeared to have left money on the table tend to have lower credit scores and be much younger and less financially sophisticated. (1, emphasis added)

This note provides an example of just how complicated the mortgage underwriting process is, particularly for less financially sophisticated borrowers.

One wonders if the CFPB should take a look at this. Should lenders be required to evaluate if joint mortgage applicants would get a better rate if only one of them ended up taking out the mortgage? And when the answer is yes, should lenders be required to share that information with the applicants? I can think of a variety of reasons why that should not be the case (not the least of which is that it could leave just one member of the family holding the bag if things go south), but it might be worth exploring this question more systematically.

First-Time Homebuyers, You’re Okay

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Couple Looking at Home

Saty Patrabansh of the Office of Policy Analysis and Research at the Federal Housing Finance Agency has posted a working paper, The Marginal Effect of First-Time Homebuyer Status on Mortgage Default and Prepayment.

While this is a dry read, it yields a pretty important insight for first-time homebuyers: you’re okay, just the way you are! The abstract reads,

This paper examines the loan performance of Fannie Mae and Freddie Mac first-time homebuyer mortgages originated from 1996 to 2012. First-time homebuyer mortgages generally perform worse than repeat homebuyer mortgages. But first-time homebuyers are younger and have lower credit scores, home equity, and income than repeat homebuyers, and therefore are comparatively less likely to withstand financial stress or take advantage of financial innovations available in the market. The distributional make-up of first-time homebuyers is different than that of repeat homebuyers in terms of many borrower, loan, and property characteristics that can be determined at the time of loan origination. Once these distributional differences are accounted for in an econometric model, there is virtually no difference between the average first-time and repeat homebuyers in their probabilities of mortgage default. Hence, the difference between the first-time and repeat homebuyer mortgage defaults can be attributed to the difference in the distributional make-up of the two groups and not to the premise that first-time homebuyers are an inherently riskier group. However, there appears to be an inherent difference in the prepayment probabilities of first-time and repeat homebuyers holding borrower, loan, and property characteristics constant. First-time homebuyers are less likely to prepay their mortgages compared to repeat homebuyers even after accounting for the distributional make-up of the two groups using information known at the time of loan origination.

So, just to be clear, being a first-time homebuyer is not inherently risky. Rather, the risks arising from transactions involving first-time homebuyers are the same as those involving repeat homebuyers:  loan characteristics, property characteristics and other borrower characteristics.