Sustainable Housing for FHA Borrowers

photo by Michael Daddino

Federal Reserve Bank of New York

Donghoon Lee and Joseph Tracy of the NY Fed have posted a staff report, Long-Term Outcomes of FHA First-Time Homebuyers. It opens,

The Commissioner of the Federal Housing Administration (FHA), David Stevens, in remarks delivered on December 12, 2009, defined the purpose of the FHA as follows. “As a mission-driven organization, FHA’s goal is to provide sustainable homeownership options for qualified borrowers.” These remarks followed a remarkable increase in the scope of the FHA mortgage insurance program in response to the financial crisis and housing bust. This comment by Commissioner Stevens is important in that it clarifies a goal of the FHA program. However, this clarity was not followed up by the FHA with a definition of “sustainable homeownership.” Nor was there any documented attempt by the FHA to develop metrics to track their progress toward this objective, or a commitment by the FHA to make this information available to the public in the future.

Program evaluation is an integral part of any effective program—government or private. We illustrate in this paper that advances in data availability offer the opportunity for the FHA to both define what it means by sustainable homeownership and to measure its progress against this definition. We believe that it would be beneficial for the FHA to be transparent in this effort and to report on not only its definition and metrics, but also on its progress on an annual basis. Improved tracking of long-term outcomes of FHA borrowers will better help inform the FHA on program design. This should lead to improved outcomes over time and enhanced public support.

We focus our analysis on first-time homebuyers who are an important market segment for the FHA. The mission of sustainable homeownership is particularly relevant for these new homeowners. The benefits of a government mortgage insurance program that helps to facilitate the transition from renting to owning rests importantly on the success of these new borrowers in remaining homeowners in the future. However, to date, the FHA has not systematically tracked the progress of its first-time homebuyers after they pay off their credit risk to the FHA. We use the New York Fed’s Consumer Credit Panel (CCP) data to do this analysis starting with the 2002 cohort of FHA first-time homebuyers. (1, footnotes omitted)

This is inarguably right. The FHA should set forth performance metrics and provide annual progress reports for them. For too long, the FHA has cherry-picked metrics without providing a holistic perspective on its performance. The authors conclude,

A stated mission of the FHA mortgage insurance program is to support sustainable homeownership. An examination of the history of the FHA program illustrates a strong initial focus on sustainability, but legislated changes in the 1950s and early 1960s shifted the focus to affordability. If sustainability remains an important goal for the FHA, then it would be desirable for the FHA to define what they mean by sustainability and to track their performance over time. Only by being transparent and holding themselves accountable can the FHA improve on this objective over time. (14)

Amen to that.

Preparing for the Next Housing Tsunami

Greg Kaplan et al. posted The Housing Boom and Bust: Model Meets Evidence to SSRN. The abstract reads,

We build a model of the U.S. economy with multiple aggregate shocks (income, housing finance conditions, and beliefs about future housing demand) that generate fluctuations in equilibrium house prices. Through a series of counterfactual experiments, we study the housing boom and bust around the Great Recession and obtain three main results. First, we find that the main driver of movements in house prices and rents was a shift in beliefs. Shifts in credit conditions do not move house prices but are important for the dynamics of home ownership, leverage, and foreclosures. The role of housing rental markets and long-term mortgages in alleviating credit constraints is central to these findings. Second, our model suggests that the boom-bust in house prices explains half of the corresponding swings in non-durable expenditures and that the transmission mechanism is a wealth effect through household balance sheets. Third, we find that a large-scale debt forgiveness program would have done little to temper the collapse of house prices and expenditures, but would have dramatically reduced foreclosures and induced a small, but persistent, increase in consumption during the recovery.

I think the last sentence is worth pondering a bit:  “a large-scale debt forgiveness program would have done little to temper the collapse of house prices and expenditures, but would have dramatically reduced foreclosures and induced a small, but persistent, increase in consumption during the recovery.” During the Great Depression, the federal government took steps that relieved the debt burden of over a million households by extending the terms of their mortgages and lowering the interest rates on them.

While this was no panacea, it did let millions stay in their homes during a period of great financial stress. The steps taken to help struggling homeowners during the recent Great Recession were much more timid than those taken during the Great Depression. This paper adds to a body of literature that suggests we should not be so timid the next time we are hit by an economic tsunami.

Retired With A Mortgage

photo by Katina Rogers

U.S. News & World Report quoted me in Rethinking a Mortgage While Retired. It opens,

It’s one of the cardinal rules of retirement planning: pay off the mortgage before quitting work. Giving up your income while still supporting a big debt can mean chewing away at your retirement savings way too fast, and can leave you in a tight spot if something goes wrong.

But paying off a mortgage years early is easier said than done, and the Center for Retirement Research at Boston College says way too many pre-retirees are too far behind schedule, largely because of borrowing before the housing bust and financial crisis.

On the other hand, some experts say carrying low-interest debt into retirement is not always such a bad thing, especially if it means leaving money in investments that perform well.

“In 2013, almost 40 percent of all households ages 55 and over had not paid off their mortgages, up from 32 percent in 2001,” the Center reports, citing a study using data from the Federal Reserve’s Survey of Consumer Finances in 2013. “These borrowers were also carrying a lot more housing debt by 2013.”

“I’ve been advising clients for over 20 years and on just an anecdotal level, I can tell you that more clients are retiring with mortgage balances than in years past,” says Margaret R. McDowell, founder of Arbor Wealth Management in Miramar Beach, Florida.

A.W. Pickel III, president of the Midwest division of AmCap Mortgage in Overland Park, Kansas, says many baby boomers traded up as their families grew, then took second mortgages to help fund college costs.

In the years before 2008, homeowners were encouraged to take out big loans when home values appeared to be soaring, the center says. They bought expensive homes or tapped home value through cash-out refinancing or home equity loans, it says.

When home prices collapsed, millions were left “underwater” – owing more than their homes were worth – and were unable to get out from under because they could not sell for enough to pay off their loan. McDowell believes many homeowners also concluded their home was not the rock-solid asset they’d thought, so they felt it unwise to pour more money into it by paying down the mortgage early.

So many just hung in there. By taking on too much debt, and monthly payments so large they could not afford extra payments to bring it down, they left themselves with too much debt too late in the game.

The center says “that 51.6 percent of working-age households were at risk of having a lower standard of living in retirement,” largely because of mortgage debt.

“In recent years, U.S. house prices have started to really improve, to the benefit of homeowners and retirees,” the center says. “But it’s difficult to predict whether the other factor that has reduced retirement preparedness – more older households with big housing debts – was a boom-time phenomenon or represents the new normal.”

But is the situation really as dire as it seems? David Reiss, a professor at Brooklyn Law School in New York City, thinks it may not be.

“According to the National Association of Realtors, the median sales price of an existing home increased from $197,100 in 2013 to $232,200 in October of 2016,” he says. “That is a roughly 15 percent price increase and about $40,000 of additional equity for the owner of the median home.”

Many homeowners who were underwater may not be any longer.

Also, he adds, it’s not necessary to be absolutely debt free at retirement so long as income is large enough to cover expenses and leave a cushion.

“Often, paying off a mortgage gets a retiree where he or she needs to be in terms of that balance, but it is not always necessary,” he says.

The key, he says, is to not be underwater. Once the remaining debt is smaller than the home value, the homeowner is better able to sell. One option is downsizing, selling the current home, then using cash from the sale or a new, smaller mortgage to buy a cheaper home. A less expensive home will also likely have lower property taxes and maintenance costs.

Mortgages from the Shadows

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Realtor.com quoted me in ‘Shadow Banks’ Are on the Rise for Home Loans: Should We Be Afraid? It opens,

Where do home buyers go for a mortgage? To a bank, of course—or at least that’s what many might think. Yet a new force has taken over home financing, called “shadow banks.” So what are these non-banks exactly, and should we run for the hills?

In a nutshell, these are the less conventional places that don’t provide savings accounts, only loans to buy homes. They include companies like Quicken Loans, which is one of the nation’s largest mortgage providers, Caliber, and loanDepot.com.

But they can also be companies run by wealthy individuals using their personal fortunes to finance loans and then pocketing monthly interest payments, according to the Wall Street Journal. Or they could be funded by private equity, which is financed by pooled investor cash.

And, as a group, they’re no longer operating on the fringes of the housing industry. Instead, shadow banks “have overtaken U.S. commercial banks, to grab a record slice” of the market,” according to a recent housing report by ATTOM Data Solutions.

This group of nontraditional lenders now accounts for 48.3% of mortgages in 2016—compared to just 23.4% in 2008, according to the ATTOM report.

“The big banks got burned by the financial crisis, so they’ve become much more hesitant to make loans that are even close to being risky,” says Daren Blomquist, senior vice president at ATTOM.

These mortgage makers are very appealing to buyers without a 20%—or even 10%—down payment and therefore have trouble getting a loan from a regular old bank, says Blomquist. This might make sense for first-time buyers, or folks who have gone through a foreclosure.

But are they right for everyone? And, more to the point: Are they harbingers of the risky loaning behavior that help bring on the U.S. housing collapse?

Could shadow banks lead to another housing crisis?

As a group, these lenders are not subject to the same level of governmental scrutiny, regulations, and fees that drove many traditional financial institutions, like banks, out of the space after the housing bust. But they still come under a significant amount of federal oversight.

In short, regular banks retreated, so shadow banks moved in. What’s wrong with that?

As market media site Seeking Alpha has pointed out, shadow banks are “some of the same characters that played leading roles [in the last housing crisis].”

Not all experts believe we should be overly worried.

“While it’s true that so-called shadow banks played roles in the last housing crisis … the market itself is very different,” says David Reiss, a professor of Law at Brooklyn Law School and editor of REFinBlog.com.

For one, the Dodd-Frank Wall Street Reform and Consumer Protection Act, passed in 2010 in response to the housing meltdown of 2008, changed how all lenders—banks, shadow banks, and otherwise—make loans, to better ensure there isn’t another housing bust.

Another big difference: Lenders are now documenting the income of borrowers to make sure these new homeowners can afford to make their monthly payments.

“There’s no evidence out there that non-banks are lending in any sort of imprudent way and/or hurting consumers,” Guy Cecala, publisher and CEO of Inside Mortgage Finance, tells realtor.com®. “In fact, most non-banks are more competitive than banks when it comes to mortgage interest rates and fees.”

“But they don’t have the same level of capital [such as cash], assets, or liquidity as banks do,” he says.

What to consider before getting a shadow bank loan

Borrowers should just take care to tread carefully and examine the terms and conditions of the financing before signing on the dotted line, says Mark Greene, a longtime mortgage lender based in Hackensack, NJ.

He recommends looking for red flags like adjustable rate change terms, prepayment penalties, and other hidden fees.

Good ol’ common sense will come in handy too.

“If your loan is coming from a fishy-sounding company like Two Brothers Fly-by-Night Hard Money-Lenders, Inc., you may want to dig a bit deeper, to figure out what kind of lender it really is,” says law professor Reiss.

REFinBlog has been nominated for the second year in a row for The Expert Institute’s Best Legal Blog Competition in the Education Category. Please vote here if you like what you read.

Ensuring Sustainable Homeownership

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My short article, Ensuring That Homeownership Is Sustainable, was just published in the Westlaw Journal, Bank & Lender Liability. It opens,

The Federal Housing Administration has suffered as a result of many of the same unrealistic underwriting assumptions that led to problems for many lenders during the 2000s. It, too, was harmed by a housing market as bad as any since the Great Depression.

As a result, the federal government announced in 2013 that the FHA would require the first bailout in the agency’s history. While facing financial challenges, the FHA has also come under attack for the poor execution of policies designed to expand homeownership opportunities.

Leading commentators have called for the federal government to stop having the FHA do anything but provide liquidity to the low end of the mortgage market.

These critics rely on a few examples of agency programs that were clearly failures, but they do not address the FHA’s long history of undertaking comparable initiatives.

 In fact, the FHA has a history of successfully undertaking new homeownership programs. However, it also has operational flaws that should be addressed before it undertakes similar future homeownership initiatives.

INTRODUCTION TO THE FHA

Mortgage insurance is a product that is paid for by the homeowner but protects the lender if the homeowner defaults on the mortgage. The insurer pays the lender for losses it suffers from the homeowner’s default. Mortgage insurance is typically required for borrowers who have limited funds for down payments.

The FHA provides mortgage insurance for loans on single family and multifamily homes, and it is the world’s largest government mortgage insurer. Other significant providers are the Department of Veterans Affairs and private companies known as private mortgage insurers.

Mortgage insurance makes homeownership possible for many households that would otherwise not be able to meet lenders’ underwriting requirements.

Just like much of the federal housing infrastructure, the FHA has its roots in the Great Depression. The private mortgage insurance industry, like many others, was decimated in the early 1930s. Companies in the industry began to fail as almost half of all mortgages went into default. The government created the FHA to replace the PMI industry, which remained dormant for decades.

In the Great Depression, the housing markets faced problems that were similar to those faced by the same markets in the late 2000s. These problems included rapidly falling housing prices, widespread unemployment and underemployment, the rapid tightening of credit and — as a result of all of those trends — much higher default and foreclosure rates.

The FHA noted in its second annual report, issued in 1936, that the “shortcomings of the old system need no recital. It financed extensive overselling of houses at inflated values, to borrowers unable to pay for them.” Needless to say, the same could be said of our most recent housing bust.

Over its lifetime, the FHA has insured more than 40 million mortgages, helping to make homeownership available to a broad swath of American households. Indeed, the FHA mortgage has been essential to America’s transformation from a nation of renters to one of homeowners.

The early FHA created the modern American housing finance system, as well as the look and feel of post-war suburban communities through the construction standards the agency set for the new houses it insured.

The FHA has also had many other missions over the course of its existence — and a varied legacy to match.

Beginning in the 1950s, the FHA’s role changed from serving the entire mortgage market to focusing on certain segments. This changed mission had a major impact on everything the FHA did, including how it underwrote mortgage insurance and for whom it did so.

In recent years, the FHA has come under attack for poorly executing some of its attempts to expand homeownership opportunities, and leading commentators have called for the federal government to stop assigning such mandates to the agency. They argue that the FHA should focus only on providing liquidity for the portion of the mortgage market that serves low- and moderate-income households.

These critics rely on a couple of examples of failed programs, such as the Section 235 program enacted as part of the Housing and Urban Development Act of 1968 and the American Dream Downpayment Assistance Act of 2003.

Those programs required borrowers to make only tiny and sometimes even nominal down payments. The government enacted the Section 235 program in response to the riots that burned through American cities in the 1960s. It was intended to expand homeownership opportunities for low-income households, particularly black ones.

The American Dream program was also geared to increasing homeownership among lower-income and minority households. The crux of the critique of these programs is that they failed to ensure that borrowers had the capacity to repay their mortgages, leading to bad results for the FHA and borrowers alike.

Notwithstanding these failed initiatives, the FHA has a parallel history of successfully undertaking new homeownership programs. These successes include programs for veterans returning home from World War II, a mission that was later handed off to the VA.

At the same time, historically the FHA has clearly suffered from operational failures that should be addressed in the design of any future initiatives.

Unfortunately, the agency has not really grappled with its past failures as it moves beyond the financial crisis. To properly address operational failures, the FHA must first identify its goals. (6-7, footnote omitted)

The Prime Crisis

Ben Franklin, Founder of the University of Pennsylvania

Fernando Ferreira and Joseph Gyourko, both at Penn’s Wharton School, have posted A New Look at the U.S. Foreclosure Crisis: Panel Data Evidence of Prime and Subprime Borrowers from 1997 to 2012 to SSRN. Unfortunately it is behind a National Bureau of Economic Research paywall. The paper makes the case for “a reinterpretation of the U.S. foreclosure crisis as more of a prime, rather than a subprime, borrower issue.” (1) The authors conclude,

The housing bust and its consequences are among the defining economic events of the past quarter century. Constructing and analyzing new and very large micro data spanning the cycle and all sectors of the mortgage market leads us to reinterpret the ensuing foreclosure crisis as something much more than a subprime sector issue. Many more homes were lost by prime mortgage borrowers, and their loss rates not only increased relatively early in the crisis, but stayed high through 2012. This new characterization of the crisis motivates a very different empirical strategy from previous research on this topic. Rather than focus solely on the subprime sector and subprime traits, we turn to the traditional home mortgage default literature that explains outcomes in terms of common factors such as negative equity and borrower illiquidity.

The key empirical finding is that negative equity conditions can explain virtually all of the difference in foreclosure and short sale outcomes of Prime borrowers compared to all Cash owners. This is true on average, over time (including the spike in their foreclosure rate beginning in 2009), and across metropolitan areas. Given the predominance of this group in terms of foreclosures and short sales, this is tantamount to explaining the crisis itself. We can explain much, but not all, of the variation in Subprime borrower outcomes in terms of negative equity or borrower illiquidity conditions, so something potentially ‘special’ about the subprime sector still is unaccounted for. That said, it also could be that a less noisy measure of borrower illiquidity would be able to account for this residual variation. That remains for future research.

None of the other ‘usual suspects’ raised by previous research or public commentators change this conclusion. Housing quality traits, household demographics (race or gender), buyer income, and speculator status do not have a material influence on outcomes across borrower types. Certain loan-related attributes such as initial LTV, whether a refinancing occurred or a second mortgage was taken on, and loan cohort origination quarter do have some independent influence, but they are much weaker than that of current LTV. (27)

I will have to leave it to other empiricists to evaluate whether this sure-to-be-controversial study is methodologically sound, but I sure did find their policy conclusion to be interesting:

We are not able to provide a definitive recommendation one way or another, but we can rule out one noteworthy reason offered for not aiding homeowners—namely, that the crisis was mostly about irresponsible subprime sector actors (both lenders and borrowers) who were undeserving of transfers. Of course, this is not to say that there was no such behavior. The evidence from other research and serious journalists is that there was. However, it is clear from the passage of time (and the accumulation and analysis of new data that provides) that the problem was much more widespread and systemic.  (28)

Hopefully, this is a lesson that we can take with us into the next (inevitable) housing crisis so we lay the foundation for policy solutions based on facts and not rely on moral judgments about borrowers that are built on shaky ground.

Reiss on Refis Redux

Refinancing must be in the air because I was interviewed twice in the last week about them. The first story appeared here. The second story, This Could Be Your Last Shot to Refinance a Mortgage, is in the Fiscal Times. It reads, in part,

After the Fed’s announcement Wednesday that it would end its historic $3 trillion bond-buying program, mortgage rates predictably began to rise.

The good news is that they were rising from the lowest rates of the year, after tumbling through most of October. At just over 4 percent, today’s mortgages rates still remain extremely low by historical standards. In 2008, before the housing busts, rates were around 6.5 percent.

*     *     *

Banks are stilled scarred from the housing bust and are dealing with significant changes to the regulatory environment, so lending standards are much tighter than they were in the past. Even former Fed chair Ben Bernanke recently admitted to having had his mortgage refinance application rejected.

To get the best rate, you’ll need excellent credit and lots of documentation of your income and assets. The average credit score for closed loans in September was 726, according to Ellie Mae.

Finally, shop around. “Talk to a big bank, talk to a little bank, talk to a mortgage broker,” says David Reiss, a professor of real estate finance at Brooklyn Law School. The gap between the best and the worst mortgage deals can be as much as a full percentage point.