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Establishing Reasonable Mortgage Underwriting Standards

It is no secret that obtaining affordable mortgage credit for both home purchases and refinancing has become increasingly difficult for many low- and moderate-income families. High FICO scores, higher down payments, and more restrictive debt-to-income requirements are now the norm, even in today’s government-dominated market.

Of course, prudent mortgage underwriting is the foundation of a sound system of housing finance and the single most effective way to mitigate risk in the system. But while underwriting standards became dangerously lax in the period leading up to the foreclosure crisis, the pendulum has now swung too far in the opposite direction.

According to news reports, the Obama administration is examining ways to stimulate the extension of mortgage credit to a broader group of potential borrowers. The hope is that a relaxation of today’s tight underwriting standards and greater clarification of the “rules of the road” for mortgage lending will safely expand the opportunity for homeownership, while contributing to our nation’s economy recovery. Some observers, however, warn that the approach being taken by the administration is simply a repeat of past mistakes and will make the housing finance system much less stable.

Whatever one’s views may be, we can all agree that this issue is of great significance and deserves further and careful consideration and discussion.

Fortunately, data exists that can help guide policy makers. In a recent study, researchers at the University of North Carolina’s Center for Community Capital found that more than 95 percent of 46,000 low-income homeowners who received traditional 30-year fixed-rate mortgages between 1999 and 2009 through Self Help Credit Union’s Community Advantage Plan were continuing to make payments at the end of the decade, despite the collapse of the housing market. The default rate for these loans—made to households with a median income of $30,000 who often put down less than 5 percent on their home purchase—was less than one-quarter the default rate of the subprime loans that they might otherwise have received (although higher than rates for prime loans without the program’s features). The researchers found that mortgages to low-income households that are well serviced, correctly structured, and avoid risky features—such as no documentation of income or assets, high upfront fees, prepayment penalties, teaser rates, and balloon payments—perform quite well.

These findings are consistent with the BPC Housing Commission’s conclusion that properly structured mortgages – when coupled with reasonable down payments – can responsibly open the door to homeownership for families with modest wealth and incomes. Housing counseling and education must also be a central component of any strategy to expand homeownership opportunities for first-time homebuyers, as noted by my fellow commission co-chair Kit Bond in a previous post.

Returning to the careful but reasonable underwriting standards that prevailed in the market before the housing bubble started would help restore balance to the system. It is instructive that the cumulative default rate of loans originated in 2000 and purchased by Fannie Mae was just a fraction of the default rate for loans originated at the height of the bubble in 2007 when prudent underwriting practices were largely abandoned.

In addition, establishing clear regulatory “rules of the road” for mortgage lenders will eliminate some of the uncertainty that exists in the market today and encourage lending to a wider circle of prospective homeowners.

Despite the Consumer Financial Protection Bureau’s promulgation of final rules on Qualified Mortgages (“QM”) and mortgage servicing, regulatory uncertainty continues to hold back private-sector involvement, thereby restricting access to affordable mortgage credit for many Americans. Federal regulators, for example, must sensibly resolve the pending rule on what constitutes a Qualified Residential Mortgage (“QRM”), if private capital is to return to the mortgage market in a more robust manner. If the regulators maintain the stringent 20-percent down payment requirement that now exists in the proposed QRM definition and fail to demonstrate how the QM and QRM rules should interact, they will add to the confusion in the marketplace and limit homeownership opportunities even further.

America is now undergoing a profound demographic transformation. Millions of Echo Boomers (those young adults born between 1981 and 1995) are now forming households for the first time. Our country is becoming increasingly diverse, with minorities, and particularly Hispanics, expected to constitute a growing share of the overall population. While members of these groups have traditionally lacked the resources for large down payments, many desire to become homeowners. Figuring out how to responsibly and effectively meet this aspiration for homeownership is a conversation worth having.

Former Housing and Urban Development Secretary Henry Cisneros serves as a co-chair of BPC’s Housing Commission.

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