A Controversial Fix for America’s Housing Market


Sustainable Economies Law Center

Insider quoted me in A Controversial Fix for America’s Housing Market: More Foreclosures. It opens,

How many people should lose their homes to foreclosure?

In an ideal world, of course, there would be no foreclosures at all. Everyone who buys a home would get one that fits their income and needs, and people would have enough money to make their mortgage payments on time and in full. But in a housing market built on debt, foreclosures are a painful reality. People lose their jobs or fall behind on payments, and lenders repossess the home to recoup their losses.

Too many foreclosures is obviously a bad thing — losing a home is devastating both financially and emotionally — but it’s also a problem to have too few foreclosures. Low rates of foreclosure activity signal that housing lenders aren’t taking enough risk, locking out hopeful buyers who could have kept up with payments on their mortgage if only lenders gave them the chance.

Most residential loans are backed by the government-sponsored enterprises Fannie Mae and Freddie Mac or the Federal Housing Administration. To try to find a happy medium of risk, the GSEs — government-sponsored enterprises — and FHA set a “credit box” to determine who gets a mortgage. The companies base these standards on factors including the borrower’s financial stability and the state of the housing market and economy. When the credit box gets tighter, fewer people get mortgages, and foreclosures generally go down. When it opens up, banks take more risks on people with lower credit scores or worse financial histories, increasing the possibility of foreclosures.

Finding the right size for the credit box is easier said than done. In the years leading up to the Great Recession, banks and private lenders handed out millions of risky loans to homebuyers who had no hope of repaying them. A tidal wave of foreclosures followed, plunging the US housing market — and the global economy — into chaos.

But some experts argue that in the years since the crash, the GSEs, lenders, and regulators overcorrected, shutting loads of potentially reliable buyers out of the housing market. Laurie Goodman, the founder of the Housing Finance Policy Center at the Urban Institute, a nonpartisan think tank, said there’s room today to “open the credit box” and relax lending standards without pushing the housing market into crisis. More foreclosures might come as a result, she said, but that would be “a worthwhile trade-off” if it gave more people the opportunity to build wealth through homeownership.

Opening the credit box isn’t a cure-all for housing, and given the weakening economy, more cautious experts argue that making it easier to get a mortgage is unnecessary or dangerous. But if lenders do it correctly, it could be a major step toward a healthier market. A more stable credit box over time could not only ensure future homebuyers aren’t locked out of getting the home of their dreams, but could also smooth out some of the market’s chaotic nature.

The ‘invisible victims’ of the housing market

In the aftermath of the Great Recession, the victims of the housing free-for-all were clear. An estimated 3.8 million homeowners lost their homes to foreclosure from 2007 to 2010, and plenty more also lost theirs in the following years. But the overly strict lending standards and tighter regulations that followed created a new class of victims: people who were unable to join the ranks of homeowners. David Reiss, a professor at Brooklyn Law School, called these would-be homebuyers “invisible victims” — people who probably could have stayed current on their payments if they’d been approved for a loan but who didn’t get that opportunity.

Taking Down Barriers to Homeownership

Laurie Goodman and her colleagues at the Urban Institute’s Housing Finance Policy Center have released a report, Barriers to Accessing Homeownership Down Payment, Credit, and Affordability. The Executive Summary states that

Saving for a down payment is a considerable barrier to homeownership. With rising home prices, rising interest rates, and tight lending standards, the path to homeownership has become more challenging, especially for low-to-median-income borrowers and first-time homebuyers. Yet most potential homebuyers are largely unaware that there are low–down payment and no–down payment assistance programs available at the local, state, and federal levels to help eligible borrowers secure an appropriate down payment. This report provides charts and commentary to articulate the challenges families face saving for down payments as well as the options available to help them. This report is accompanied by an interactive map.

Barrier 1. Down Payments

• Consumers often think they need to put more down than lenders actually require. Survey results show that 53 percent of renters cite saving for a down payment as an obstacle to homeownership. Eighty percent of consumers either are unaware of how much lenders require for a down payment or believe all lenders require a down payment above 5 percent. Fifteen percent believe lenders require a 20 percent down payment, and 30 percent believe lenders expect a 20 percent down payment.

• Contrary to consumer perceptions, borrowers are not actually putting down 20 percent. The national median loan-to-value (LTV) ratio is 93 percent. The Federal Housing Administration (FHA) and US Department of Veterans Affairs (VA) typically offer lower down payment options than the government-sponsored enterprises (GSEs), from 0 to 3.5 percent. As the share of FHA and VA lending has increased considerably in the post-crisis period (since 2008), the median LTV ratio has increased as well.

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Barrier 2. The Credit Box

• Access to homeownership is not limited by down payments alone. Credit access is tight by historical standards. Accordingly, the median credit score of new purchase mortgage originations has increased considerably in the post-crisis period. The median credit score for purchase mortgages is 779, compared with the pre-crisis median of 692. Credit scores of FHA borrowers have historically been lower; the current median credit score is 671.

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Barrier 3. Affordability

• Because of home price appreciation in the past five years, national home price affordability has declined. Low interest rates have aided affordability. If interest rates reach 4.75 percent, national affordability will return to historical average affordability.

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Access to Down Payment Assistance

• Low–down payment mortgages and other down payment assistance programs provide grants or loans to potential homeowners all over the country. There are 2,144 active programs across the country, and 1,295 agencies and housing finance agencies offering them at the local, state, and national levels. One of the major challenges of the offerings in each state is that they are not standard, eligibility requirements vary, and not all lenders offer the programs. Pricing for the programs also vary, so counseling and consumer education about the programs is necessary to ensure consumers understand how the program works and any additional costs that may be incurred.

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• Eligibility for down payment assistance programs is determined by such factors as loan amount, homebuyer status, borrower income, and family size. Assistance is available for many loan types including conventional, FHA, VA, and US Department of Agriculture (USDA) loans. The share of people eligible for assistance in select MSAs ranges from 30 to 52 percent, and the eligible borrowers could qualify for 3 to 12 programs with down payment assistance ranging from $2,000 to more than $30,000.

Because of the tight credit environment, many borrowers have been shut out of the market and have not been able to take advantage of low interest rates and affordable home prices. As the credit box opens, educating consumers about low–down payment mortgages and down payment assistance is critical to ensuring homeownership is available to more families. (V-VI, emphasis removed)

Mortgage Credit Conditions Easing

Home of Easy Credit

The Urban Institute’s Housing Finance Policy Center has released its July Housing Finance at a Glance. It opens,

Our latest update to HFPC’s Credit Availability Index (HCAI) shows early signs that the overly tight mortgage lending standards of the post-crisis period may finally be starting to ease. This HCAI update shows improvements for both GSE and FHA/VA channels. Between Q3 2013 and Q1 2015, the expected mortgage default rate increased from 1.8 to 2.1 percent (17 percent increase) for GSE originations, and from 9.6 to 10.8 percent (a 13 percent increase) for FHA/VA originations. The expected default rate for portfolio loans and PLS channels has remained largely flat at 2.6 percent over this period.

Long overdue, these improvements are largely a result of efforts to clarify put-back standards and conduct early due diligence. While the FHA has lagged the GSEs in these efforts, it has made some progress. Still, more needs to be done, especially to mitigate uncertain lender litigation risk arising out of FHA’s False Claims Act.

These improvements notwithstanding, there is still significant room to safely expand the credit box. Even if the mortgage market had taken twice the default risk it took in Q1 2015, that level would have still been below the level of default risk of the early 2000s. (3)

This excellent chartbook contains many very interesting graphs. I recommend that you look at the National Housing Affordability Over Time graph in particular. It shows that housing “prices are still very affordable by historical standards, despite increases over the last three years.” (16)

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