Do you want to buy a house but worry that your credit profile will disqualify you for a mortgage? Take another look: A new study suggests that you might find lenders a little friendlier and more flexible than you thought. According to the Urban Institute Housing Finance Policy Center’s latest quarterly credit availability report, mortgage lenders are reaching out to borrowers who might have been marginal — or rejectees — in the past. Lenders are increasing their appetite for at least slightly riskier applicants — people with lower credit scores, higher debt-to-income ratios, smaller down payments and other issues.
The institute’s study, released last week, suggests that Fannie Mae and Freddie Mac, the dominant players in the market, both have been taking on more risk “steadily since the financial crisis.” The Federal Housing Administration (FHA), Department of Veterans Affairs (VA) and the Department of Agriculture’s rural home loans program have pushed risk to “the highest level since 2009.” Portfolio and “private label” lenders — a category that ranges from giant banks to independent mortgage companies — have also been reaching deeper into the credit pool, but risk for them remains near record lows.
If you’re a credit-strained buyer, this may sound just fine. But there’s potentially a darker side: If you’re a taxpayer worried about more billion-dollar bailouts, this can look ominous. Could this steady increase in risk put us on course to another toxic-loan crisis? Laurie Goodman, vice president of the Housing Finance Policy Center, says not to worry. She told me that current lender risk levels are still well below historical norms, specifically the “reasonable lending standards” that prevailed in 2001 through 2003, before the boom. “Significant space remains to safely expand the credit box,” according to Goodman’s analysis in the latest report.
Great. But not everybody in the mortgage industry is convinced by such assurances. John Meussner, executive loan officer with Mason-McDuffie Mortgage Corp. in San Ramon, California, sees hints of trouble ahead. “I have definitely noticed a fast uptick in ‘creative’ [loan] products coming out,” he told me. “Recently we saw one investor roll out a product offering up to $2 million in financing for FICO scores down to 600.” The loan allows borrowers to have made a late payment on a mortgage within the past 12 months and have multiple credit incidents (such as a bankruptcy or foreclosure). The loan also requires the borrower to have just three months of reserves for loan amounts to $1 million. “This is something we haven’t seen since before the crash,” said Meussner.
He said some lenders are dumbing down on FICO scores as well, soliciting applications with scores in the mid-500s in combination with relatively skimpy down payments and “varying degrees of risk layering.” FICO scores, which are used in most home-loan financings, run from 300 to 850, with the highest risks of future default associated with low scores. Scores below 620 indicate noteworthy credit issues in the borrower’s past. Average FICOs for home-purchase loans acquired by Fannie and Freddie hover close to 750.
Within the past 18 months, Meussner said he has seen a sizable jump in loan offerings that contain layers of risk piled on top of one another, plus “increasingly ‘creative’ documentation standards.” He emailed me one example of how documentation rules — the bedrock of sound underwriting practices in the post-crash era — can be compromised. In an online lenders’ chatroom, a sales representative of a wholesale mortgage company said his firm would approve a loan to borrowers who can’t or won’t document their earnings — essentially a “stated income” loan harking back to the Wild West days of 2005 and 2006 when they were commonplace but later led to massive defaults and foreclosures. “Stated income” back then meant: You tell the lender what you earn and the lender accepts it, no verification needed.
“Typically,” said Meussner, “this is how the trouble begins.”
Other lenders see things starkly differently. Paul Skeens, president of Colonial Mortgage Group in Waldorf, Maryland, says documentation is still a big deal for most lenders reaching out to home buyers who are marginal credit risks. “They continue to scrutinize applicants and their documents in unbelievable detail,” said Skeens.
That may be why they’re generally not seeing a lot of defaults. Angel Oak Mortgage Solutions, the largest volume company specializing in “non-qualified mortgage” loans that allow borrowers more generous terms than permissible at Fannie or Freddie, says its default rate is exceptionally low, but it did not provide a specific figure.