Tag Archives: DTI

P2P, Mortgage Market Messiah?

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Monty Python's Life of Brian

As this is my last post of 2015, let me make a prediction about the 2016 mortgage market. Money’s Edge quoted me in Can P2P Lending Revive the Home Mortgage Market? It opens,

You just got turned down for a home mortgage – join the club. At one point the Mortgage Bankers Association estimated that about half of all applications were given the thumbs down. That was in the darkest housing days of 2008 but many still whisper that rejections remain plentiful as tougher qualifying rules – requiring more proof of income – stymie a lot of would be buyers.

And then there are the many millions who may not apply at all, out of fear of rejection.

Here’s the money question: is new-style P2P lending the solution for these would-be homeowners?

The question is easy, the answers are harder.

CPA Ravi Ramnarain pinpoints what’s going on: “Although it is well documented that banks and traditional mortgage lenders are extremely risk-averse in offering the average consumer an opportunity for a home loan, one must also consider that the recent Great Recession is still very fresh in the minds of a lot of people. Thus the fact that banks and traditional lenders are requiring regular customers to provide impeccable credit scores, low debt-to-income (DTI) ratios, and, in many cases, 20 percent down payments is not surprising. Person-to-person lending does indeed provide these potential customers with an alternate avenue to realize the ultimate dream of owning a home.”

Read that again: the CPA is saying that for some on whom traditional mortgage doors slammed shut there may be hope in the P2P, non-traditional route.

Meantime, David Reiss, a professor at Brooklyn Law, sounded a downer note: “I am pretty skeptical of the ability of P2P lending to bring lots of new capital to residential real estate market in the short term. As opposed to sharing economy leaders Uber and Airbnb which ignore and fight local and state regulation of their businesses, residential lending is heavily regulated by the federal government. It is hard to imagine that an innovative and large stream of capital can just flow into this market without complying with the many, many federal regulations that govern residential mortgage lending. These regulations will increase costs and slow the rate of growth of such a new stream of capital. That being said, as the P2P industry matures, it may figure out a cost-effective way down the line to compete with traditional lenders.”

From the Consumer Financial Protection Bureau (CFPB) to Fannie and Freddie, even the U.S. Treasury and the FDIC, a lot of federal fingers wrap around traditional mortgages. Much of it is well intended – the aims are heightened consumer protections while also controlling losses from defaults and foreclosures – but an upshot is a marketplace that is slow to embrace change.

Frannie v. Private-Label Smackdown

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Eric Armstrong

S&P posted a report, Historical Data Show That Agency Mortgage Loans Are Likely to Perform Significantly Better Than Comparable Non-Agency Loans. The overview notes,

  • We examined the default frequencies of both agency and non-­agency mortgage loans originated from 1999­-2008.
  • As expected, default rates for both agencies and non-­agencies were higher for crisis-­era vintages relative to pre­-crisis vintages.
  • The loan characteristics that were the most significant predictors of default were FICO scores, debt­-to­-income (DTI) ratios, and loan­-to­-value (LTV) ratios.
  • Agency loans performed substantially better than non­agency loans for all vintages examined. The default rate of agency loans was approximately 30%-­65% that for comparable non-­agency loans, whether analyzed via stratification or through a logistic regression framework. (1)

This is not so surprising, but it is interesting to see the relative performance of Frannie (Fannie & Freddie) and Private-Label loans quantified and it is worth thinking through the implications of this disparity.

S&P was able to do this analysis because Fannie and Freddie released their “loan-level, historical performance data” to the public in order to both increase transparency and to encourage private capital to return to the secondary mortgage market. (1) Given that the two companies have transferred significant credit risk to third parties in the last few years, this is a useful exercise for potential investors, regulators and policymakers.

It is unclear to me that this historical data gives us much insight into future performance of either Frannie or Private-Label securities because so much has changed since the 2000s. Dodd-Frank enacted the Qualified Mortgage, Ability-to-Repay and Qualified Mortgage regimes for the primary and secondary mortgage market and they have fundamentally changed the nature of Private-Label securities. And the fact that Fannie and Freddie are now in conservatorship has changed how they do business in very significant ways just as much. So, yes, old Frannie mortgages are likely to perform better, but what about new ones?

Mortgage Market, Hiding in Plain Sight

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David Jackmanson

I blogged about the Center for Responsible Lending’s take on the 2014 Home Mortgage Disclosure Act (HMDA) data yesterday.  The mere act of aggregating this data reveals so much about the state of the mortgage market. Today I am digging into it a bit on my own.

There is a lot of good stuff in the analysis of the HMDA data released by the Federal Financial Institutions Examination Council (FFIEC). I found the discussion of the effects of the Qualified Mortgage and Ability to Repay rules most interesting:

The HMDA data provide little indication that the new ATR and QM rules significantly curtailed mortgage credit availability in 2014 relative to 2013. For example, despite the QM rule that caps borrowers’ DTI ratio for many loans, the fraction of high-DTI loans does not appear to have declined in 2014 from 2013. However, as discussed in more detail later, there are significant challenges in determining the extent to which the new rules have influenced the mortgage market, and the results here do not necessarily rule out significant effects or the possibility that effects may arise in the future. (4)

This analysis is apparently reacting to those who have claimed that the new regulatory environment is restricting lending too much. The mortgage market is generally too complicated for simple assertions like “new regulations have restricted credit too heavily” or “not enough” There are so many relevant factors, such as changes in the interest rate environment, the unemployment rate and the change in the cost of housing, to be confident about the effect of the change in regulations, particularly over a short time span. But the FFIEC analysis seems to have it right that the new regs did not have such a great impact when they went into effect on January 1, 2014, given the similarities in the 2013 and 2014 data. This reflects well on the rule-writing process for the QM and ATR rules. Time will tell whether and how they will need to be tweaked.

While the discussion of the new rules was comforting, I found the discussion of FHA mortgages disturbing: “The higher-priced fraction of FHA home-purchase loans spiked from about 5 percent in early 2013 to about 40 percent after May 2013 and continued at monthly rates between 35 and 52 percent through 2014, for an annual average incidence of about 44 percent in 2014.” (15) Higher-priced first-lien loans are those with an APR that is at least one and a half percentage points higher than the average prime offer rate for loans of a similar type.

The FHA often provides the only route to homeownership for first-time, minority and lower-income homebuyers, but it must be monitored to make sure that it is insuring mortgages that homeowners can pay month in and month out. If FHA mortgages are not sustainable for the long run, they are likely to do homebuyers more harm than good.

Going It Alone on Your Mortgage

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walking alone

WiseBread quoted me in When It Makes Sense to Apply for a Mortgage Loan Without Your Spouse. It opens,

You and your spouse or partner are ready to apply for a mortgage loan. It makes sense to apply for the loan jointly, right? That way, your lender can use your combined incomes when determining how much mortgage money it can lend you.

Surprisingly, this isn’t always the right approach.

If the three-digit credit score of your spouse or partner is too low, it might make sense to apply for a mortgage loan on your own — as long as your income alone is high enough to let you qualify.

That’s because it doesn’t matter how high your credit score is if your spouse’s is low. Your lender will look at your spouse’s score, and not yours, when deciding if you and your partner qualify for a home loan.

“If one spouse has a low credit score, and that credit score is so low that the couple will either have to pay a higher interest rate or might not qualify for every loan product out there, then it might be time to consider dropping that spouse from the loan application,” says Eric Rotner, vice president of mortgage banking at the Scottsdale, Arizona office of Commerce Home Mortgage. “If a score is below a certain point, it can really limit your options.”

How Credit Scores Work

Lenders rely heavily on credit scores today, using them to determine the interest rates they charge borrowers and whether they’ll even approve their clients for a mortgage loan. Lenders consider a FICO score of 740 or higher to be a strong one, and will usually reserve their lowest interest rates for borrowers with such scores.

Borrowers whose scores are too low — say under 640 on the FICO scale — will struggle to qualify for mortgage loans without having to pay higher interest rates. They might not be able to qualify for any loan at all, depending on how low their score is.

Which Score Counts?

When couples apply for a mortgage loan together, lenders don’t consider all scores. Instead, they focus on the borrower who has the lowest credit score.

Every borrower has three FICO credit scores — one each compiled by the three national credit bureaus, TransUnion, Experian, and Equifax. Each of these scores can be slightly different. When couples apply for a mortgage loan, lenders will only consider the lowest middle credit score between the applicants.

Say you have credit scores of 740, 780, and 760 from the three credit bureaus. Your spouse has scores of 640, 620, and 610. Your lender will use that 620 score only when determining how likely you are to make your loan payments on time. Many lenders will consider a score of 620 to be too risky, and won’t approve your loan application. Others will approve you, but only at a high interest rate.

In such a case, it might make sense to drop a spouse from the loan application.

But there are other factors to consider.

“If you are the sole breadwinner, and your spouse’s credit score is low, it usually makes sense to apply in your name only for the mortgage loan,” said Mike Kinane, senior vice president of consumer lending at the Hamilton, New Jersey office of TD Bank. “But your income will need to be enough to support the mortgage you are looking for.”

That’s the tricky part: If you drop a spouse from a loan application, you won’t be penalized for that spouse’s weak credit score. But you also can’t use that spouse’s income. You might need to apply for a smaller mortgage loan, which usually means buying a smaller home, too.

Other Times to Drop a Spouse

There are other times when it makes sense for one spouse to sit out the loan application process.

If one spouse has too much debt and not enough income, it can be smart to leave that spouse out of the loan process. Lenders typically want your total monthly debts — including your estimated new monthly mortgage payment — to equal no more than 43% of your gross monthly income. If your spouse’s debt is high enough to throw this ratio out of whack, applying alone might be the wise choice.

Spouses or partners with past foreclosures, bankruptcies, or short sales on their credit reports might stay away from the loan application, too. Those negative judgments could make it more difficult to qualify for a loan.

Again, it comes down to simple math: Does the benefit of skipping your partner’s low credit score, high debt levels, and negative judgments outweigh the negative of not being able to use that spouse’s income?

“The $64,000 question is whether the spouse with the bad credit score is the breadwinner for the couple,” says David Reiss, professor of law with Brooklyn Law School in Brooklyn, New York. “The best case scenario would be a couple where the breadwinner is also the one with the good credit score. Dropping the other spouse from the application is likely a no-brainer in that circumstance. And of course, there will be a gray area for a couple where both spouses bring in a significant share of the income. In that case, the couple should definitely shop around for lenders that can work with them.”

Countercyclical Regulation of Housing Finance

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Pat McCoy has posted Countercyclical Regulation and Its Challenges to SSRN. The abstract reads,

Following the 2008 financial crisis, countercyclical regulation emerged as one of the most promising breakthroughs in years to halting destructive cycles of booms and busts. This new approach to systemic risk posits that financial regulation should clamp down during economic expansions and ease during economic slumps in order to make financial firms more resilient and to prick asset bubbles before they burst. If countercyclical regulation is to succeed, however, then policymakers must confront the institutional and legal challenges to that success. This Article examines five major challenges to robust countercyclical regulation – data gaps, early response systems, regulatory inertia, industry capture, and arbitrage – and discusses a variety of techniques to defuse those challenges.

Readers of this blog will be particularly interested in the section titled “Sectoral Regulatory Tools.” (34 et seq.) This section gives an overview of countercyclical tools that can be employed in the housing finance sector:  loan-to value limits; debt-to-income limits; and ability-to-repay rules. McCoy ends this section by noting,

The importance of the ability-to-repay rule and the CFPB’s exclusive role in promulgating that rule has another, very different ramification. It is a mistake to ignore the role of market conduct supervisors such as the CFPB in countercyclical regulation. The centrality of consumer financial protection in ensuring sensible loan underwriting standards – particularly for home mortgages – underscores the vital role that market conduct regulators such as the CFPB will play in the federal government’s efforts to prevent future, catastrophic real estate bubbles. (44)

While this seems like an obvious point to me — sensible consumer protection acts as a brake on financial speculation — many, many academics who study financial regulation disagree. If this article gets some of those academics to reconsider their position, it will make a real contribution to the post-crisis financial literature.

Reiss on Home Mortgage Disclosure Act Proposed Rulemaking

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I have submitted a Comment on Home Mortgage Disclosure Act Proposed Rulemaking to the Consumer Financial Protection Bureau.  Basically, I argue

The Consumer Financial Protection Bureau’s Home Mortgage Disclosure Act proposed rulemaking (proposed Aug. 29, 2014) is a reasonable one.  It increases the amount of information that is to be collected about important consumer products, such as reverse mortgages.  It also increases the amount of important information it collects about all mortgages.  At the same time, it releases lenders from having to determine borrowers’ intentions about how they will use their loan proceeds, something that can be hard to do and to document well.  Finally, while the proposed rule raises some privacy concerns, the CFPB can address them.

 

Reiss on New Mortgage Regime

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Loans.org quoted me in a story, CFPB Rules Reiterate Current and Future Lending Practices. It reads in part,

David Reiss, professor of law at the Brooklyn Law School, said there could be other long-term effects due to this high DTI ratio since the lending rules will likely remain for several decades.

If the rules remain intact, the high DTI number can still be lowered at a later time. For instance, if few defaults occur when the bar is set at 43 percent, the limit might increase. Conversely, if a large number of defaults occur, the limit will decrease even further.

Reiss hopes that the agencies overseeing the rule will make these changes based on empirical evidence.

“I’m hopeful that regulation in this area will be numbers driven,” he said.

Despite the wording, Bill Parker, senior loan officer at Gencor Mortgage, said that lenders are technically “not required to ensure borrowers can repay their loans.” He said lenders are legally required to make a “good faith effort” for reviewing documents and facts about the borrower and indicating if he or she can repay the debt.

“If they do so, following the directives of the CFPB, then they are protected against suit by said borrower in the future,” Parker said. “If they can’t prove they investigated as required, then they lose the Safe Harbor and have to prove the borrower has not suffered harm because of this.”

The statute of limitations for the CFPB law is three years from the start of loan payments. After that time period, the lender is no longer required to provide evidence of loan compliance.

Even though the amendment could impact the current lending market, experts told loans.org that the CFPB’s standards will make a greater impact on the future of the housing industry.

Reiss believes that the stricter rules will create a sustainable lending market.