Long-term housing finance reform is essential for removing the uncertainty surrounding mortgage finance. In addition, there are a number of immediate challenges for homebuyers trying to finance a house. Most importantly, it is far too difficult for many qualified people to obtain a mortgage.
When the Bipartisan Policy Center (BPC) Housing Commission released its report in February 2013, we discussed this environment of tight mortgage credit and outlined the obstacles that prevent many families from entering the homeownership ranks. Little has changed in the subsequent 14 months. The following obstacles, identified in the report, persist: overly strict lending standards; lack of access to credit for well-qualified self-employed individuals; put-back risk (where lenders are uncertain about the “rules of the road” holding them liable for representations and warranties associated with loans purchased by the GSEs); appraisals; and uncertainty related to pending regulations and implementation of new rules.
Wall Street executive Lew Ranieri emphasized this concern when he spoke at a BPC forum last year on the consequences of the tight mortgage credit environment. He noted that over the past 50 years loans were made to a broad cross-section of borrowers, and that since the introduction of credit scores in the 1990s, those with 700, 650, and even 620 FICO scores who had the income required to make monthly principal and interest payments received loans. In fact, prior to the economic downturn, a 620 FICO with a 5 percent down payment was an insurable prime loan, while loans to borrowers with FICO scores below 620 were considered to be non-prime. However, in today’s conventional market, “680 has become the new 620.”1
This tight credit environment is demonstrated by reviewing the historical dataset released by Freddie Mac in December 2013. Whereas Freddie Mac FICO scores from 1999 to 2002, well before the Great Recession, averaged 714, after the recession the average exceeded 760 for the period 2009 to 2012. In addition, in each of the years between 1999 and 2002, over 35% of the loans had FICO scores below 700.2
To be clear, we are not calling for a return to the underwriting that helped bring the Great Recession, but rather to the sound underwriting standards in place in the late 1990s and early 2000s. Even with these less restrictive FICO score requirements, single-family mortgage loans originated during this period had cumulative default rates well below 2 percent, which compares very favorably with the default rates of 10 percent or more at the height of the housing boom. So it is possible to inject greater flexibility into the underwriting process without necessarily increasing the risk of default.
The problems caused by this quest for pristine mortgage credit were also pointed out by Elizabeth A. Duke, a Member of the Board of Governors of the Federal Reserve System, in a talk given last May. She noted that the drop in mortgage originations between 2007 and 2012 has been most pronounced among borrowers with lower credit scores: “Between 2007 and 2012, originations of prime purchase mortgages fell about 30 percent for borrowers with credit scores greater than 780, compared with a drop of about 90 percent for borrowers with credit scores between 620 and 680. Originations are virtually nonexistent for borrowers with credit scores below 620.”
We need to deal with long-term housing finance reform, but in the meantime, we also need to do more to help qualified people obtain a mortgage today. As we do so, we will provide an important boost to the housing market and to the economy.
1 Ranieri, Lewis S., Rosen, Kenneth T., Goldhaber, Mark, & Lepcio, Andrea, “The Future of Home Finance: Who Will Qualify?,” October 2013, Ranieri Partners Management, LLC and Rosen Consulting Group, p. 6.
2 The dataset was released by Freddie Mac at the direction of its regulator, the Federal Housing Finance Agency (FHFA) in December 2013. It includes data on a portion of Single Family mortgages acquired by Freddie Mac and includes approximately 17 million loans.