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Is 'tight' mortgage credit a myth?

Most indicators suggest that credit for homebuyers remains tight. Borrowers are having a harder time getting home loans — not only by the standards of the bubble years, but by the standards of the early 2000s, which many analysts use as the measure of a normal market.

Zillow reported last week that credit remained significantly tighter at the end of last year than in its benchmark year of 2002. The Mortgage Bankers Association (MBA) reports credit is nearly four times as tight as it was in 2004, before the housing market overheated, and more than eight times tighter than during the bubble years of 2005 to 2007.

A recent Urban Institute study said if lenders underwrite loans to the same standards as in 2001, as many as 4 million loans could have been originated between 2009 and 2013. Because lenders have applied tougher standards, those loans are “missing.”

Another think tank, the American Enterprise Institute’s (AEI) International Center on Housing Risk, however, says these studies are not only wrong, they perpetuate a fable that tight credit has held back home sales because relatively safe borrowers can’t get loans.

“I would classify it as a myth,” Edward Pinto, co-director of the AEI center, said.

AEI’s evaluation of millions of loans in its database concluded that credit is not tight — not even by the standards of the early 1990s, which it says is a more appropriate measure of a normal market. Credit should be called “loose” compared to the early 2000s, AEI says, because mortgage rates are significantly lower and credit standards aren’t markedly different.

Pinto said loans are readily available to borrowers with credit scores below 660 — the demarcation line of a subprime borrower — and have debt-to-income ratios of more than 43 percent. This, he said, is particularly true of Federal Housing Administration (FHA) loans, where borrowers typically put just 5 percent down on 30-year-fixed mortgages and can qualify with credit scores of less than 600.

Pinto also noted that traditional banks, like Wells Fargo and JP Morgan Chase & Co., have tightened their standards, but non-banks with looser standards have filled the void. He cited one non-bank lender, Pacific Union Financial, that has been originating loans with a median FICO of 654, roughly 50 points less than the big banks.    

“The percentage of people with perfect credit is actually quite high, 60 percent, but that means that 40 percent don’t have perfect credit who are purchasing homes,” Pinto said. “You hear it all the time, you hear it from [Federal Reserve Chair] Janet Yellen, only people with pristine or perfect credit can get loans. The data shows that 40 percent of the people getting loans now do not have pristine or perfect credit.”

Studies suggest credit standards are tighter

Average credit scores and other indicators, however, suggest that credit remains tighter now than the early 2000s.

Zillow is one of the few companies that monitors credit availability and provides a data set that goes back beyond a decade. According to its data, the average credit score of borrowers in the lowest 10th percentile, on the cusp of getting denied, stood at 674 in the fourth quarter of 2014. That was up from 636 during the benchmark year in 2002, and up from 631 during several months of the bubble years of 2006 and 2007.

Six of Zillow's seven indicators point to tighter credit today than in early 2002. Only the spread between 30-year-fixed rates and 10-year treasury rates points to looser standards today than in 2002. The spread between the two is narrower now, an indication that the interest-rate penalty for taking out a riskier long-term mortgage isn’t as high.

Zillow’s credit availability at the end of 2014 stood at 69.4, which is 30 points tighter than 2002, and 50 points tighter than when the market was at its loosest in April 2007.

MBA reported in March that its credit availability index stood at a still tight 121.4. The index was benchmarked at 100 in 2012, when credit was near the tightest point.  

"Our estimate is that in 2006 that same index would have been about 850, and that was sort of the height of the boom,” MBA’s Chief Economist Michael Fratantoni said. “Perhaps that is not to where anybody would like to return. But even if you look at a year like 2004, where you had somewhat more typical credit conditions, it was at about 400. By that measure, even though we have seen some loosening over the past couple of years, it is still a very tight credit environment.”

Fratantoni said that credit has only noticeably eased at the top end of the market for jumbo loans, remaining tight for first-time borrowers who often get lower-balance loans.  

“The tight credit is having an impact on the ability of first-timers and self-employed borrowers to qualify for a loan,” Fratantoni said.“We do expect it to get somewhat better as economic conditions continue to improve, but relative to history, we are still in a very tight credit environment.” 

Is it hard to get a mortgage? 

Others in the mortgage industry have questioned the official industry line that credit is “tight,” however.  

“There is a false narrative out there,” said Joe Parsons, senior loan officer with the California-based PFS Funding. “The narrative goes something like this: ‘Gee, rates are really good today, but who can qualify anymore because lending standards are too tight, [and] the banks are cherry-picking just the very best customers with perfect credit.’ Now, that simply is not true.”

Parsons, a mortgage banker and broker, says he frequently puts home loans into the hands of borrowers with less-than-perfect credit. Typically, he only originates conventional Freddie Mac and Fannie Mae loans — those loans considered the safest and theoretically the hardest to obtain.

He said a borrower can qualify for a GSE loan with a credit score of 620 — hardly pristine credit. Parsons said underwriters have become noticeably more picky since new consumer financial protection rules became effective last year, opening up lenders to penalties and legal liability if loans default.

“Those standards haven’t particularly changed,” Parsons said. “The process has changed because files are not just being reviewed, they are really being audited, so we have to paper-trail all of the money. We have to write letters of explanation. We have to do what we should have been doing all along, but the credit standards themselves are not onerous, in my opinion.”


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