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'Tight' Lending May Not Hinder Housing

Banks have eased off the brakes of mortgage lending, but are standards still too tight

Way too tight, contend real estate industry and lending advocates, who say banks' reticence to lend has prevented a more robust housing recovery.

But other industry observers worry that the push to open up lending is a race back to the reckless lending standards that helped inflate the housing bubble that burst in 2006.

"Has the National Association of Realtors since 1924 ever said lending standards are too loose? The answer is no. That has never happened," said Ed Pinto, former Fannie Mae (FNMA) chief credit officer and now resident fellow at the conservative American Enterprise Institute.

Pinpointing where standards are today in relation to the loose years before the bubble popped almost seven years ago — and in more normal periods before the bubble — can be difficult. Loan quality is judged on several standards: borrowers' credit scores, their mortgage and other debt payments as a share of income, the loan size relative to the property value. Average loan data can mask worsening loan quality in some borrower segments if there are changes for the better in others.

Return To Century's Start

Jonathan Corr, chief operating officer of Ellie Mae (ELLI), thinks that on balance, banks are roughly back where they were in 2000-01. The main difference is that banks are verifying data on borrowers, he says.

"There was not a lot of real disciplined underwriting going on," he said. "That was a recipe for disaster and that was what we saw.

FICO scores — the widely used measure that ranks a borrower's credit history from 300 to 850 — have climbed for both approved purchase loans and refinance applications. The average credit score of a borrower approved for a loan in April declined but was a high 742, according to Ellie Mae, a software provider to lenders. It was the fifth consecutive month of easing standards. But the average of all denied loans was a relatively healthy 701, according to the latest Ellie Mae data.

Real estate tracking firm Core-Logic (CLGX) says approved loan FICOs for home purchases — stripping out refinances — averaged 741 in 2012. The average score was a much lower 709 in 2004, as the bubble gained steam. But it actually rose slightly to 713 in 2005 and 716 in 2006, when the mania ended.

And back in 2000, the average was 696. So based on that measure, standards appear tight. There are other moving parts. Down payments are larger now for conventional loans. And the average borrower's total debt-to-income is lower today.

CoreLogic says debt cost about 34% of total income in 2012 for borrowers approved for new-purchase loans. The ratio was almost 38% in 2005 and 39% in 2006. An average loan was 83.67% of home value in 2012, up from 79.94% in 2005.

Meanwhile, the housing market is mending. Interest rates have edged up but remain near historic lows. Home prices appear to have lifted off a rocky bottom and are climbing in most markets, according to data from the National Association of Realtors and the closely watched Case-Shiller Home Price Indices.

"I think we've all been surprised by the amount of improvement we've seen," said Mark Fleming, chief economist at CoreLogic, speaking of the housing market.

"Some have said that credit is tight and the average FICO score of a person who received credit was somewhere around 760 and the average of someone declined is 720. But the average LTV (loan-to-value ratio) of those declined credit was 88%. Were they being declined for insufficient credit score? What were they being declined for? Lack of equity.

Down Payments At Issue

Fleming says homebuyers seeking to put only 2% to 5% down are getting FHA mortgages.

Down payments have become a contentious topic. An unusual consortium of banks, consumer advocates, homebuilders and lawmakers have lined up against regulators' proposal that a new "Qualified Residential Mortgage" certification include a requirement for 20% down.

The 2010 Dodd-Frank financial legislation requires that banks retain a 5% interest in the loans they sell to investors as mortgage-backed bonds unless the loans meet the QRM standard defined by regulators. The QRM stamp would mean the loan had safeguards built in, making a default less likely.

Banks don't want the heightened down-payment standards that would restrict their ability to fully sell loan portfolios. And housing advocacy groups don't want the higher standards because they say it will lock out many potential borrowers.

Together they're pushing for the QRM to match the "Qualified Mortgage" rule — a looser concept hammered out by the new Consumer Financial Protection Bureau.

That QM definition has some language on ensuring borrowers can actually afford the loan. By writing mortgages that meet the definition, banks will reduce their legal liability if the loans go sour. The standard precludes negative amortizing loans that have borrowers falling behind on the principal even as they make full monthly payments. But it's silent on a base down payment.

"We really, really do not want the government to set a down payment," said Kathleen Day, spokeswoman for the Center for Responsible Lending, a left-leaning advocacy group. "We think there should be down payments, but we think the market should set them.

Pinto says QM already allows "a loan with a zero down payment, with a 50%-plus debt ratio and a 580 FICO to be called prime as long as it goes through a Fannie, Freddie (Mac) (FMCC) or FHA underwriting system. The FHA underwriting systems will approve that loan today. So that's a prime loan? Well, that's not a prime loan.

But consumer advocates and bankers alike say requiring banks to keep 5% "skin in the game" in loans without a full 20% down will derail the housing recovery and keep qualified borrowers out of homes.

Jed Smith, director of research for the Realtor association, says members report that two-thirds of their clients put down less than 20%.

"A lot of people are struggling to put down even 10%," he said.

Pinto says by fighting requirements that borrowers have enough skin in the game to avoid more mass foreclosures, the advocacy groups are seeding the next bubble.

"They're all talking about affordable housing, but ... they support policies that in the end drive up the price of housing," he said.

Donna Howell contributed to this story.