One of the main questions hanging over the Federal Reserve’s plan to buy up to $40 billion a month in mortgage-backed securities (MBS) to help spur the housing market is whether continuing tight underwriting requirements will offset any positive impact the effort will have on lowering mortgage interest rates.
NAR Chief Economist Lawrence Yun and other analysts have said that interest rates, already at historical lows, don’t need to come down further to spur home buying. What needs to happen instead is a change in lenders’ underwriting policies. Since the downturn, lenders have been imposing underwriting restrictions on borrowers that go above and beyond what Fannie Mae, Freddie Mac, and FHA require for loans. For example, borrowers in some cases need to have a credit score 100 points higher than what Fannie, Freddie, or FHA require.
These restrictions, or overlays as they’re sometimes called, on federally backed loans are crucial, because Fannie, Freddie, and FHA comprise so much of the mortgage lending market today. Lenders say they need these higher standards to ensure they don’t make loans on which borrowers subsequently default and then face having to take them back if Fannie, Freddie, or FHA say the loan violated the “representations and warranties” the lender made when they originated the loans.
As Yun said in his monthly press conference yesterday, to release August existing-home sales figures, despite improvement in home sales and prices, these standards are keeping otherwise creditworthy households from getting financing, which could lead to wide and troubling disparities in home ownership rates down the road. “The tight underwriting standards are not a trifle matter,” he said. They’re “limiting who can become home owners and setting the stage for possible highly unequal wealth distribution in five years, because who will be getting [home price] appreciation over the next five years? They’re limiting the number of people in the middle who can become home owners.”
Federal Reserve Chairman Ben Bernanke, at a press conference he held last week to announce the MBS purchase plan, known as QE3, (for “quantitative easing 3, because it’s the third such measure the Fed has taken since the downturn), said these tight underwriting standards are in fact easing. “As house prices have begun to rise, as the economy has gotten a little stronger, lending standards have eased just a bit,” he said. “There have also been other changes which are useful. I note for example that the FHFA (Federal Housing Finance Agency) and the GSEs (Fannie and Freddie) have recently changed their policy on put-backs, so that banks will have more certainty under what conditions a mortgage will be put back to them if it defaults. So, there are a number of things in train that will make the mortgage market a little bit more open. That is one factor actually that could make our policy more effective, rather than less effective over time. If more people have access to more credit, more people will have access to the low rates we’re providing.”
Other than the policy clarification on put-backs, also known as loan repurchases or loan buy-backs, Bernanke didn’t specify what those eased lending standards are. And, whatever they are, they don’t appear to be trickling down to many real estate practitioners on the ground. NAR just last week released survey findings that suggest tight standards continue to be a problem. In one of the findings, in about 75 percent of loans to Fannie and Freddie last year, borrowers had credit scores of 740 or above, compared to just 40 percent of borrowers between 2001 and 2004 who did so. The years 2001 to 2004 are considered stable and healthy, before the housing boom. The difference in credit scores suggests up to 700,000 more loans could have been made last year had that the tight restrictions not been in place.
”Financial institutions appear to be focusing on making loans only to individuals with the highest levels of credit scores,” Jed Smith, NAR manager of quantitative analysis, says in his anlaysis of the survey findings.
All this is just another way of saying, as many of the reporters at Chairman Bernanke’s press conference last week were saying (see first video), that the MBS purchase plan might be all the Fed can do, given it’s mandate to focus on monetary policy (matters affecting the supply of money in the economy), but it misses the point. The problem is in lenders’ underwriting policies. And interest rates that go lower than even today’s historically low rates seem unlikely to have much impact on those.
In the first video above, Bernanke makes some key housing market points, including about easing loan standards, as he talks about the Fed’s MBS purchase plan. In the second video, Yun talks about the continuing tight underwriting standards.
Insufficient staff to process loan applications and to get timely and accurate appraisals are two of the reasons lenders say are impeding their ability to originate and purchase more home loans, results from the Federal Reserve’s most recent quarterly lender survey shows. the report was released at the end of April but it has some interesting findings that are important today.
Lender Survey, April 30, 2012
The Fed surveys lenders every three months to find out if lending standards are tightening or loosening, and in this latest three-month period they’re loosening, but not by much. As the Fed says in its inimicable prose, “A moderate net fraction of banks reported anticipating increasing their exposure to residential real estate assets over the next year.”
What’s interesrting about the report is that lenders say larger down payments aren’t that big of a deal to them for making more loans to borrowers with lower credit scores. Assuming borrowers with a FICO score of 620 made a downpayment of 20 percent rather than 10 percent, only a “moderate net fraction of banks” would make more loans, the Fed report says.
The idea that doubling the downpayment won’t lead to that much change in bank lending practices is consistent with what NAR has been saying for years in connection with federal banking regulators’ proposed qualified residential mortgage (QRM) rule. Regulators in drafting the rule have talked about imposing a stiff downpayment requirement to help ensure the rules create a class of loans that are considered safe, and thus can be sold 100 percent to investors. (If they’re not considered “safe,” lenders would have to retain 5 percent of the loan amount on their books, making the loans more expensive for borrowers.)
NAR has been saying all along that Congress never wanted banking regulators to impose a minimum downpayment requirement and has also been saying that larger downpayments aren’t what’s key when it comes to making safe loans. Rather, sound underwriting is the important factor, and this latest data from the Fed appears to back that up pretty clearly.
For borrowers with higher credit scores, in the 720 range, lenders said doubling the downpayment to 20 percent from 10 percent would likely induce them to make loans to these borrowers at about the same rate as they would have back in 2006, which would represent a “somewhat” higher percntage of loans than if borrowers put down 10 percent. Again, that sounds like anything but an endorsement of the idea that large downpayments equate to safe mortgages.
The survey also indicates that lenders continue to hold back in their residential lending in part because of regulatory uncertainty, which likely includes uncertainty over what that QRM rule will look like once its finally published, and what another lending rule, the so-called QM rule, will look like. The QM rule is the qualified mortgage rule and it’s a broad rule that the Consumer Financial Protection Bureau (CFPB) is writing to require lenders to ensure all borrowers who receive mortgage loans have the ability to repay the loan.
NAR has been saying that this QM rule needs to be broad and non-prescriptive so lenders can look at each loan application individually and make a lending decision based on the facts in each applicant’s file rather than be constrained by a cookie-cutter approach to evaluating applicants.
In any case, this latest Fed survey makes clear that lenders are not looking to big downpayments to improve loan quality, and at the same time, they don’t like all this uncertainty that these and other pending rules are imposing on the market. QRM and QM stem from the big Wall Street reform law that was enacted after the mortgage meltdown and now here we are two years later and lenders remain in a holding pattern.
Perhaps once they get some regulatory clarity they’ll start staffing up more to address the problem of insufficient staff for processing loans. But while regulatory clarity is important, it’s no doubt more important for the federal government to get the policy right, which means not releasing QM and QRM rules that are overly prescriptive.
Read the Fed report for yourself. It’s called the Senior Loan Officer Opinion Survey on Bank Lending Practices, April 30, 2012.
Federal Reserve Board Chairman Ben Bernanke told the U.S. House Budget Committee last week that tight mortgage conditions are preventing a stronger economic revovery because their adverse effect on home buyers is keeping inventory levels high, damping appreciation, and holding back new construction.
“Although low interest rates on conventional mortgages and the drop in home prices in recent years have greatly improved the affordability of housing,” households aren’t able to take advantage of these good conditions, he said.
Bernanke agreed with a question posed to him by Rep. John Campbell (R-Calif.) that there are steps Congress could take to ease regulatory issues that are contributing to the lending problem.
“I don’t think this is purely a market phenomenon,” he said. “I think there are a number of legal and administrative and regulatory barriers to housing being as strong as it should be.”
Although he didn’t go into detail at the hearing, a white paper the Fed sent to Congress two weeks ago lays out some of the issues it sees as a problem. One of them has to do with repurchase requirements by Fannie Mae and Freddie Mac. These requirements reduce lenders’ willingness to lend without strict underwriting overlays because based on certain underwriting matters, if the loans go bad, they could be on the hook to Fannie or Freddie for them.
Overlays are requirements over and above minimum underwriting standards of Fannie and Freddie and FHA.
“This hesitancy on the part of lenders is due in part to concerns about the high cost of servicing in the event of loan delinquency and fear that the GSEs could force the lender to repurchase the loan if the borrower defaults in the future,” the Fed says in the paper.
Also in the white paper, the Fed said Congress should consider allowing Fannie and Freddie, which are under federal conservatorship, to absorb some short-term losses if that would help get housing sales moving again, and that the two companies should be allowed to make some REO homes they hold in their inventory available to buyers for use as rentals.
President Barack Obama in his State of the Union speech last week and in a more detailed plan he released earlier this week is pursuing a limited pilot program with Fannie Mae to allow some REO sales for use as temporary rentals in some markets. NAR has said it wants to be sure the pilot is open to small- and medium-sized investors, not just big investors, and that real estate practitioners be used in the transactions to make sure they’re done in such a way that they don’t destabilize the local markets.
After Bernanke’s House Budget Committee testimony, NAR President Moe Veissi released a statement in support of the need for a sustained federal focus on the struggling housing market.
“We fully support Chairman Bernanke’s comments that the lack of available and affordable mortgage financing, low home values and high foreclosure inventories are inhibiting a meaningful housing market recovery,” he said. “His remarks coupled with President Obama’s new housing proposal announced earlier this week, shows that the administration and Federal Reserve recognize the vital role that real estate plays in both the short- and long-term health of the nation.”
In the video clip above, Bernanke talks about the barriers to a housing recovery. To watch the entire video, go to Bloomberg’s website.
The Federal Reserve urged lawmakers and the administration this week to take a more hands-on approach to the housing market because the market’s continued struggles is holding back strong economic recovery. In a report it just sent to legislative leaders, it said lenders are keeping lending standards too tight, in part because of their concerns over bad-loan buy-back policies of Fannie Mae and Freddie Mac.
Under the policies, the secondary mortgage market companies make banks take back their loans if the loans are found to be underwritten in such a way that borrowers are unable to maintain their payments.
In a Wall Street Journal piece today on the Fed report, the Fed is reportedly concerned that lenders’ hesitancy to loosen overly tight standards is keeping households from taking advantage of the ultra-low interest rates the Fed has been encouraging.
The Fed suggested the agency that regulates Fannie and Freddie, the Federal Housing Finance Agency, should allow the two secondary mortgage market companies to absorb some short-term losses to enable an improving housing market to buoy the economy. “Some actions that cause greater losses to be sustained by the [companies] in the near term might be in the interest of taxpayers to pursue if these actions result in a quicker and more vigorous economic recovery,” the Fed said, as reported by the Journal.
The Fed is also recommending Fannie and Freddie convert some of their foreclosed single-family houses into rentals to get them out of the for-sale inventory, helping prices, and also to help meet solid rental housing demand.
By Robert Freedman, senior editor, REALTOR® Magazine
The first thing to note about the congressional super committee’s failure to agree to deficit cuts is that MID is spared for the time-being. Among the deals the members of the deficit-cutting committee looked at was a change to itemized deductions, including the mortgage interest deduction. That change was rejected, and in any case no broader deal was worked out. So, MID is off the table for the moment. But it’s worth noting that it was one of the few big-ticket items that got a serious look, which suggests that it will remain a target into the foreseeable future.
What happens next? According to NAR Tax Director Linda Goold, unless Congress passes legislation to change things, some $1.2 trillion in federal programs will be automatically cut in 2013. If that happens, communities in which defense bases and other defense resources play a big role will be hit hard, because defense is slated to take the biggest cut of all. That means bases could be scaled back, and if that happens, the communities in which those bases are housed will see reduced demand for home sales and rentals.
HUD programs will be cut, too. That will mainly hit rental subsidy programs, but it will also hit community development block grants (CDBG) and HOME Investment Partnership grants, which provide grants to communities for affordable housing.
Of course, the broader impact is what all this is doing to our economy. Long-term rates are expected to remain low, if only because the Federal Reserve has said it intends to keep them low. But could the U.S. see another cut in its credit rating? At what point will investors, including foreign investors, start reducing their Treasury purchases?
Plus, there are some wildcards: some estate tax laws are expiring in 2012, as are the tax cuts that were put into place by President George W. Bush in 2001. And in 2013 the deficit ceiling will have to be raised again. What all this means is that we’re looking at another year of deficit-cutting debates in Congress.
NAR Tax Director Linda Goold looks at what we can expect as a result of the super committee’s lack of agreement in the five-minute video above.
By Robert Freedman, senior editor, REALTOR® Magazine
A banking reform rule proposed by the FDIC and Federal Reserve earlier this month to require 20 percent minimum down payments on residential mortgage loans is based on the idea that loans with higher down payments perform better than those with lower down payments. As recently as last week, FDIC General Counsel Michael Krimminger told a House Banking subcommittee that his agency’s studies show “a significant relationship between higher loan-to-value ratios and increased risk of default.”
The Fed and FDIC’s 20-percent minimum-down proposal isn’t for all residential mortgages; it’s just for mortgages that get included in securities and sold to investors. If lenders don’t want to require a minimum 20 percent down, they just need to hold at least 5 percent of the value of the loan on their books. If they don’t want to retain that 5 percent, then they would have to require that minimum 20 percent down.
Source: Community Mortgage Banking Project
It’s hard to argue with the regulators that, in an ideal world, households would put down 20 percent when taking out a mortgage to buy a house. And indeed, the FDIC isn’t the only entity to find a relationship between high down payments and loan performance. The Community Mortgage Banking Project, a coalition of independent mortgage bankers, points to its own work showing a small correlation between down payment amount and performance—but with the emphasis on small.
In an analysis of the performance of loans made between 2002 and 2008, loans on which the down payment is increased from 5 percent to 10 percent showed improvement of between 0.1 percent and 0.5 percent. No, those aren’t typos. The gains are that small.
There was a little bit better improvement when down payments were increased from 5 percent to 20 percent. Performance improved between 0.3 percent and 1.6 percent.
Any time you can improve loan performance it’s a good thing, but to get these small levels of improvement, the market for home sales would have to shrink enormously, between 6.6 percent and 14.7 percent in the case of requiring a minimum 10 percent down, and between16.7 percent and a whopping 28.8 percent in the case of requiring a minimum 20 percent down. The market would shrink that much because requiring those higher down payments would drive huge numbers of households out of the market.
In other words, what the FDIC and Federal Reserve want to do is lop off almost a third of the home sales market to get up to 1.6 percent improved loan performance.
By Robert Freedman, Senior Editor, REALTOR® Magazine
The Federal Reserve’s move to boost the economy with $600 billion in U.S. Treasury bond purchases earlier this week helped ignite the stock market and could also help real estate in the short term if businesses follow suit by adding jobs.
NAR Chief Economist Lawrence Yun told REALTORS® at the 2010 Conference & Expo today that job growth is key to getting home sales back up to where they should be based on historic norms. Although housing markets are steadily improving and prices are stabilizing, home sales remain at levels last seen in 2000, when the U.S. had 30 million fewer people.
Yun says weak consunmer confidence, which is a function of continuing high unemployment (about 9.6 percent currently), is behind the lag, so anything that can boost job growth could help home sales.
But the latest Fed stimulus could come with a cost, says Federal Reserve Governor Thomas Koening. Joining Yun at the REALTORS® conference to talk about the residential housing market, Koening said continued efforts to stimulate the economy could spark inflation, particularly with the federal budget deficit already at historically high levels. Koening was the only Fed governor to vote against the new stimulus. Continue reading »
By Robert Freedman, senior editor, REALTOR® Magazine
You might be wondering what’s in the 2,300 pages of financial services reform that has just passed Congress. It now goes to President Obama for signature.
Relatively few of the pages of legislation touch on real estate finance directly. Much of the bill addresses the way hedge funds, banks, and other financial services companies are regulated. One of its centerpieces is the new Financial Stability Oversight Council, which will have the job of issuing alerts when it sees lending practices becoming too risky.
But there are pieces of the legislation that could impact you.
By Robert Freedman, Senior Editor, REALTOR® Magazine
Watch our videos for economic research updates further down the post.
In the midst of the mortgage meltdown it was hard to keep track of everything the federal government was doing to keep the credit freeze from sinking the economy. There was the massive bank rescue, with the idea that an equity infusion from taxpayers would shore up banks so they could start financing mortgages again; there was the temporary increase in loan limits in high-cost areas for loans backed by Fannie Mae, Freddie Mac, and FHA; and there was the first-time home buyer tax credit, now expanded to include move-up buyers.
But one federal effort that never received quite the same attention as the others, probably because it doesn’t lend itself to a term that rolls off the tongue like “tax credit” or “bank bailout,” is the Federal Reserve’s massive intervention in the mortgage-backed securities market. Continue reading »
By Katie Tarbox, Senior Editor, REALTOR® Magazine
The opening session of Inman Real Estate Connect 2010 in New York was markedly more optimistic than just a year ago where practitioners gathered at the Marriott Marquis for the three-day conference. While still cautious, Brad Inman, the founder of Inman News, said he was encouraged by the fact that the stock market has been so bullish since March of last year in his kickoff speech.
However, he also warns that some hesitation is in order, and recommended watching the following closely: Continue reading »
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