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   ARTICLE   |   From Scotsman Guide Residential Edition   |   July 2013

Finding and Defining Today’s Normal

Lenders’ ability to avoid risks without stifling industry recovery is critical

Each month, the National Association of Realtors (NAR) surveys thousands of its members about the difficulties that their clients are having in getting a mortgage. One finding in particular has been present for several consecutive months: “Realtors continued to express concern over unreasonably tight credit conditions. Mortgage lenders appear to continue to display an unnecessarily high level of risk aversion. In the 2001-04 time frame, approximately 40 percent of residential loans went to applicants with credit scores above 740. Currently, the percentage is in the 50 percent range. Estimates by NAR economists have indicated that an additional 500,000 to 700,000 additional sales could be made if credit conditions returned to normal."

The operative word here is “normal.” It goes without saying that many mortgage professionals hope that this will not be the old normal — that is, the conditions of 2001 to 2007 that made credit too easy for hundreds of thousands of homeowners and gave them mortgages for which they never should have qualified. Waves of defaulting borrowers ignited a housing crash that cost millions of families their homes. By the end of 2011, homeowners had lost about $7 trillion in household wealth, according to the Federal Reserve. Because of the housing bust, the net worth of America’s households declined almost 40 percent from 2007 to 2010.
In this environment, what is the new “normal,” and how is it impacting the mortgage market as a whole?

Reduced risk

Clearly, “normal” doesn’t mean the new normal that is keeping nearly half of purchase-mortgage applicants from closing. From 2007 through 2010, lenders raised standards to reduce risk, the intended result of which was to require better documentation, better credit and more skin in the game from borrowers in the way of downpayments and loan-to-value ratios. 

These higher standards have worked remarkably well. The risk of defaults on mortgages currently being originated is only 13 percent higher than the average of similar loans originated in the 1990s, according to a third-quarter ’12 report from University Financial Associates (UFA).

“UFA’s nominal, five-year house price forecasts are solidly positive at both the state and metro-area levels,” wrote Dennis Capozza, the Dale Dykema professor of business administration at the University of Michigan and a founding principal of UFA. “With the risk of falling house prices greatly diminished, default risks on new mortgage loans are also reduced.”

This continuing trend to more favorable conditions is encouraging many lenders to be more aggressive in pursuing business, resulting in more financing being available for mortgage markets. Arguably, the environment for mortgage investment is the best it’s been since before the housing crash.

"This continuing trend to more favorable conditions is encouraging many lenders to be more aggressive in pursuing business, resulting in more financing being available for mortgage markets. Arguably, the environment for mortgage investment is the best it’s been since before the housing crash."

Loosening standards

In response to these positive conditions, there are signs some lenders are easing their credit standards for newly originated loans. For instance, according to Ellie Mae’s Origination Insight Report, the closing rate on mortgage loans was 53.2 percent this past April, up from 47.1 percent in November 2011. In addition, the median loan-to-value ratio for all mortgages hit 81 percent, up from 76 percent in November 2011. 

Undoubtedly, lenders that are targeting the purchase-mortgage business as rising rates reduce refinances will find that exercising a little wiggle room on their lending standards will give them a competitive advantage without inviting much risk. This, at least, is what a growing number of bank-risk professionals are starting to believe.

Expectations among bank-risk professionals for the relaxation of lending standards increased sharply this past first quarter, rising to 19.9 percent from 12.1 percent in fourth-quarter ’12, according to a survey by FICO.

In other words, about one in five of these professionals now expect the approval criteria for loans to become less stringent, the third-highest level ever registered for looser lending standards in the three-year history of the FICO survey. The rising expectation for looser standards is a reversal of views from this past fourth quarter, when the professionals’ expectations were at their lowest level in the survey’s history.

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At the end of the day, “normal” may not be the old normal or the new normal, but a normal that’s yet to come — one in which mortgage professionals apply what’s been learned about managing mortgage risk to create an approval process with underwriting standards that lenders and borrowers can live with.


 


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