Are tight lending standards the go-to fall guy in this economic cycle? It would seem so.
Wall Street Journal’s Nick Timiraos sparked a recent Twitter discussion on this topic when he shared an article Mark Zandi, Moody Analytics Chief Economist, wrote. Mr. Zandi believes lending standards will hamstring a struggling housing market, and should be loosened. A number of Nick’s followers jumped in to agree.
A lively discussion followed. David Stevens, CEO of the Mortgage Bankers Association and Christopher Whalen of Carrington do not agree with my stance on this topic, a stance which from which I will not waver.
While true that by historical standards we currently have a low rate of mortgage buyers, I do not believe lending standards are the reason, nor that the standards are too tight .
I believe the reasons are weak incomes, lack of liquid assets, too much debt (especially student loan debt), the labor force falling down, and a host of others having nothing to do with lending standards.
However, lets forget about my economic ramblings and consider Mark Zandi’s points, one at a time.
“ For the housing recovery to maintain its momentum, first-time and trade-up home buyers must pick up the slack. Yet these buyers face a significant barrier: Today only those with the cleanest of credit records are able to obtain mortgage loans. The average credit score on loans to buy homes last year was above 750 (on a scale of 300 to 850), some 50 points higher than the average for all consumers, and 50 points higher than the average among those who received mortgages a decade ago, before the housing bubble.” - Zandi
This is false. Loans buyers with low fico score loans and low down-payments have been available to first time home buyers and move up buyers this entire cycle. The fact that Mark Zandi claims these loans are not available makes clear his lack of experience in the lending business.
In fact,you could have gotten a mortgage with a 620 Fico, 3.5% down-payment and debt to income ratios to 43%-50% for the last few years. Even today you can get an 80% loan with a fico of 620.
Further, his use of the average score of those who bought homes as proof that lending standards are too tight is flawed analysis. The score reveals more about the buyers’ credit quality on average, but not that lending standards are tight. We must remember that there is no subprime lending in the mortgage business anymore, and that this is a good thing.
Some may point to the auto loan business, which offers sub prime lending and which is experiencing a boom, as proof than housing should follow suit. However, the debt structure of car loans is much different than housing, and cant fuel the fires of trouble that sub prime loans in housing can (and once did).
“Several mutually reinforcing factors are keeping credit tight.
First, lenders are less willing to take on risk, in part because they were burned in the housing collapse. Moreover, there are other costs associated with riskier lending, including legal and reputation problems related to loan defaults and the additional infrastructure and manpower needed to service distressed borrowers.” - Zandi
Lenders are giving loans to people with 620 Fico Scores and 3.5% down. How much more risk do you want them to take? Notice Mark Zandi doesn't come out and say we should go back to 100% loans or even give a Fico limit. Lending guidelines are back to normal and since we haven't seen normal in a long time we mistake this as being tight.
“Lenders are also adjusting to changes related to the Dodd-Frank financial overhaul. One of the most significant is the qualified mortgage rule, which provides a safe harbor from borrower suits under the Truth in Lending Act. Many lenders will not make loans that fall outside of that safe harbor, and those who do are likely to restrict them to wealthy borrowers or those with very high credit scores.” - Zandi
Barring debt to income ratio being moved down from 45% to 43% a lot of the new QM ( qualified mortgage) guidelines have already been accepted by the market place. Also, lenders will do non -QM loans and even interest only loans but they will do them for the upper income home buyers in America. What I am trying to stress here is that the guidelines that we have seen in the last few years, and in place today, are not overly stringent.
“Lastly, lenders are turning away many borrowers who meet the requirements for government-backed mortgages because of uncertainty about the government’s rules for loans that are deemed faulty because of underwriting mistakes. When a lender makes a loan insured by Fannie Mae, Freddie Mac or the Federal Housing Administration, it is with the understanding that the lender will not bear the cost of a default. But the government can force a lender to absorb the cost if the lender did not follow correct underwriting rules. In recent years, Fannie, Freddie and the FHA have been much more aggressive about returning defaulting loans to lenders.” - Zandi
He is correct that that fear of loans being deemed faulty due to underwriting mistakes have made banks very cautious. However, to then leap to the assumption that fear of put back wars prevents banks from lending to qualified home buyers is flawed thinking.
I have yet to see a transaction go bad when the buyer has the financial ability to own the house. In fact the only reasons I have seen a loan get declined is that the appraisal value comes in low or a condo project doesn't get approved.
To be clear, this does not mean that a complex tax return or a deposit hasn't bested an underwriter and prevented a qualified home buyer from obtaining a home loan. No doubt this occurs from time to time. However, in all honesty this is a very small drop in the pool of transactions.
The reason why my neck neck hairs rise when I hear lending standards blamed for the low mortgage numbers, is that by pointing to a red herring, the real problems are overlooked.
So what are the reasons more mortgages are not being written during a time or relative low interest rates?
Here are the reasons I believe fewer folks qualify for mortgages.
1. Incomes are weak. Years of soft income growth has caught up to an economy that is based on debt consumption.
2. Debt to Income ratios are too high. The current household debt to income ratio when purchasing a home is too high even after all the de leveraging that has gone on.
3. Liability to Income ratio is too high. These are the real line by line item costs monthly expense costs Americans pay for recurring needs that don't properly show up on Debt to Income ratios. Many Americans add these monthly expenses, such as cable bill, insurance bill and others, to credit cards because cash flow isn't that great.
4. American jobs do not, on average, pay enough to sustain an increase in mortgage applications and approvals. Since the majority of the jobs recovered have been in the low wage service sector and going to people 50 and over, the improving employment picture has not done much to help housing. Many Americans are making less than what they made during the housing bubble economic cycle so the debt to income and liability to income ratios aren't as strong as pundits think. The after tax expense incomes for Americans is not rosy.
5. Student loan debt is affecting the young’s ability to purchase their first home. This debt stands at 1 trillion dollars and growing. Unlike the other household debt that can be written off in a Bankruptcy filing, or through foreclosure or a short sale, f, student loan debt just grows and grows and grows. This is the one household debt that has been rising through out this cycle.
6. Americans are just a bit more reasonable on taking on debt. I coined the phrase LTI ( Liability to Income) to capture and present the idea that for most Americans, what matters is how much they must spend, line by line, to pay their regular monthly bills. It is clear that even when a person has little debt, if their monthly expenses plus a new house payment will exceed their ability to pay, the mortgage will fall into trouble.
Progress I have seen in this cycle is that Americans aren't as willing or likely to borrow maximum amount of money they might have in the past. They have budgets and know how much their total mortgage payment which include principal, interest, taxes and insurances is. This is a plus for America because this means they have more money in their pockets at the end of the month.
7. Renting is a great idea for many, including the young. Mobility is a key asset in the job hunting game and with many young Americans delaying marriage and starting a family, adding on the biggest debt they will likely ever have isn't their biggest priority.
8. The old adage promoted by many real estate agents that one’s home is one’s best investment is questioned. Individuals should look at housing as the cost of shelter, and take on only the debt they can afford to pay, for that shelter. This is and should be a different perspective that that of Wall Street firms or foreign cash buyers who are looking for yield investments or wanting a place to park cash. The theory that buying a home will allow the homeowner to both live in it, and watch the investment grow is no longer accepted by many Americans. Now, they are more likely to believe it is the payment they are buying. If you don't believe me, ask the millions of Americans who are still underwater.
9. Economics cycles seek equilibrium. Since 1968 we have been in a very long economic cycle driven by Globalization, Technology, Debt and Demographics. In this phase capital gets better treatment that labor. So, if incomes don't grow in an economy based on debt, and that economy has has no financial bubble to create fake demand to create fake well paying jobs, then you get this type of cycle we are seeing right now. But, as I’ve pointed out before, the financial heads in New York, Washington D.C. and San Francisco just don't get the struggles of Main Street America.
So if I haven't convinced you that it's not lending standards that are too tight but it's the economy, then I did a poor job, because math, data and facts should win out in the end.
However, as always I challenge the Wall Street Journal, CNBC, Bloomberg, BusinessInsider, Trulia, Zillow and the NAR to an open forum debate on this issue. Prove me wrong with facts not assumption or academic reports because I know all too well they aren't telling you the real story.
On a final note, I will tell you when I believe the housing story is getting better. It will be when we see Main Street Americans buy homes, when first time home buyers buy homes in a bigger percentage fashion than what we have seen these last few years. The problem we have with this housing cycle is that housing inflation is running higher on both fronts now, and we are so asking Main Street America to buy and pay more for a home that went up in value not because of economic strength but because the housing bubble hangover left an inventory crisis for this country. So when people say lending standards are too tight, I say it's the economy stupid.
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