Action on Loan Standards Needed More than on Rates

The Federal Reserve hopes to drive down already low interest rates and reboot the sluggish economic recovery by buying up some $40 billion in mortgage-backed securities a month. But there’s a reason to wonder if a different kind of action would be better at getting the economy moving. And that’s a restoration of sensible underwriting standards by lenders so buyers can take advantage of these low rates.

As NAR Chief Economist Lawrence Yun and other economists and analysts have noted, mortgage and other interest rates are already at historical lows. So, for the Fed to try to drive rates down even more really raises the question of how much more demand in home ownership markets can realistically be expected if rates drop from 3.6 percent to, say, 3.3 percent?

What’s more, rates might not even go down as a result of the Fed action, because if inflation-fearing investors sell MBS holdings faster than the Fed buys new MBS issuances, then long-term rates might actually go up—just the opposite of what the Fed hopes will happen.

Be that as it may, as NAR has pointed out repeatedly, and as Federal Reserve Chairman Ben Bernanke has himself said, the sluggish housing recovery, which is keeping the broader economy from seeing faster growth, isn’t just a product of less-than-optimal market demand; it’s a product of too-tight underwriting standards among lenders.

Back in February, in his testimony before the House Budget Committee, Bernanke was very clear that he saw these restrictive standards as a part of what’s wrong with the recovery. “The problems with access to credit in the mortgage market mean the Federal Reserve’s monetary policy is not as effective as it otherwise would be,” Bernanke said on Feb. 3. “Because not as many as could be are taking advantage of the low mortgage rates that we have tried to create. . . . I don’t think this is purely a market phenomenon. I think there are a number of legal and administrative and regulatory barriers to hosing being as strong as it should be.”

Bernanke didn’t identify the legal, administrative, and regulatory barriers he was alluding to. But among the possible barriers that lenders have talked about are loan repurchase rules Fannie Mae and Freddie Mac have in place. Lenders have cited their loan repurchase risk as one of the reasons they’ve imposed underwriting standards on Fannie- and Freddie-backed loans that go beyond the minimum requirements of the agencies. Under these repurchase rules, Fannie and Freddie can require lenders to buy back their loans if the agencies determine the loans aren’t underwritten exactly in accordance with their standards. So lenders, to ensure they don’t get hit with a repurchase requirement, go above and beyond the agencies’ requirements. (FHA and private investors have repurchase rules, too.)

The Federal Housing Finance Agency, the conservator of Fannie and Freddie, has since issued a release intended to clarify the loan repurchase policies of Fannie and Freddie, but the policies themselves haven’t changed.

On top of that, the Consumer Financial Protection Bureau and other regulators are working on rules to implement the big Wall Street reform law enacted two years ago and these rules, even though they’re not finalized, have lenders concerned about what the underwriting picture will look like down the road. Those are the qualified mortgage (QM) and qualified residential mortgage (QRM) rules. QM requires lenders to make loans only to borrowers who can demonstrate the ability to repay and outlines how that’s defined and also under what legal standard lenders would have to meet if they’re charged with making a loan that’s outside the ability-to-repay standard. QRM requires lenders to retain 5 percent of the loan amount on their books if the loan is going to be securitized and sold to investors. The 5-percent hold-back requirement is waived for loans that meet banking regulators’ underwriting standards.

NAR has expressed concern with draft versions of both rules and has said the rules should be broad and flexible, otherwise we’ll see the same problem that we’re seeing with the loan repurchase rules: lenders will tighten standards so much that even creditworthy borrowers would be challenged to get financing at affordable costs and in a timely manner.

And then there are changes to bank capital standards by the international Basel III protocol, which isn’t implemented yet but is already causing concern among lenders because they could face increased requirements for holding capital on their books for every loan they make.

When you step back and consider all these matters together, you get an environment that’s not conducive to the kind of lending that’s needed to get the housing market back on a strong growth footing. NAR has been saying for years that lenders simply returning to the safe and reasonable standards they had in place before the housing boom would go a long way in getting the market going.

Along these lines, NAR this morning released survey findings that suggest we could see half a million more home sales a year, and possibly more, if lenders simply went back to their previous safe standards.

In the survey, 75 percent of mortgage loans made today go to borrowers with credit scores of 740 or higher, compared to before the boom—2001 to 2004—when about 42 percent of loans went to borrowers with scores that high.

“A loosening of the overly restrictive lending standards is very much in order,” Yun said in a statement that accompanied the release of the findings.

NAR also today sent a letter to Bernanke suggesting that the Fed, although it doesn’t have a formal role in all of the mortgage rules being drafted, it can play a role in communicating concerns over how the rules are written. “The Fed should work to ensure that these rules take reasonable steps to reduce risk without inhibiting access to mortgage credit,” NAR President Moe Veissi said in the letter.

Robert Freedman

Robert Freedman is director of multimedia communications for the NATIONAL ASSOCIATION OF REALTORS®. He can be reached at

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  1. Lenders are really hurting Buyers by giving approval then changing their requirement just days before closing. I have some where the seller has already
    moved and the buyer has moved and is living in a motel awaiting closing which is now delayed by new requirements. Formerly if you got an approval in writing you could depend on it, but now there is no control on how the lender can jack the buyer around. This is so costly that people are getting afraid to make a move.
    I have been in this business for more than 30 years and I have never seen such deciet on the part of lenders. The buyers and sellers should be able to sue the lender for damages, that might stop it. When I give out information in writing it should be correct.