With the housing market in a clear decline, it shouldn’t come as a shock that mortgage credit availability reached its lowest level in nine years this past July, according to a Mortgage Bankers Association (MBA) report. It’s important to note that lenders aren’t necessarily being more restrictive in terms of borrower or product risk. Rather, they’re looking to cut expenses, and fewer product offerings are a way to do that.
Still, the MBA data is yet another marker on a lengthy trail of declining mortgage credit options since the Great Recession. For many years, the Urban Institute’s Housing Finance Policy Center has tracked credit availability through the conventional, government and private lending channels. As of first-quarter 2022, its index stood at 4.9%, meaning that roughly one in 20 purchase loans given to owner-occupants were judged as likely to become delinquent by 90 days or more during the life of the loan. This share is about half of what it was from 2001 to 2004, a period characterized by the policy center as having “reasonable lending standards.”
Working with borrowers who can get approved, that require a little more effort, would be a good thing.
— Laurie Goodman, founder, Urban Institute Housing Finance Policy Center
Following the market crash in 2008, loan risk was significantly reduced and essentially has been aligned with borrower risk ever since. Laurie Goodman, the policy center’s founder, chalks this up to the disappearance of loan features such as negative amortization, 40-year terms and very short reset periods for adjustable-rate products.
“The market basically said, ‘We don’t want any more of this,’ and then that was sort of codified in the qualified mortgage rule (of 2014),” Goodman says. “But more fundamentally, our risk tolerance as a society has gone way down. We’re not willing to tolerate as many low credit-score borrowers, specifically, as we once were.”
Indeed, that statement is reflected in data collected by the Urban Institute. This past May, the median FICO score of 750 was 27 points higher than pre-housing crisis levels. Much of this tightening has occurred near the bottom of the credit spectrum as the 10th percentile borrower now has a median FICO score of 659, about 50 points higher than pre-bubble days.
Mortgage credit inquiries dropped by nearly 30% from May 2021 to May 2022, according to data analytics company CreditXpert. But interest remained steady or even increased among people with credit scores below 600. Mike Darne, CreditXpert’s vice president of marketing, says that a lack of refinance lending opportunities has likely fueled the inquiry declines of 20% to 40% or more among the bulk of the market (i.e., people with scores between 620 and 820).
“There was a huge spike in 2020 and 2021 in those upper bands, and I think it was largely driven by homeowners seeking refis,” Darne says. “But we haven’t seen any softening down on the lower bands. People are still continuing to step up to the plate and inquire about a mortgage.”
The previous boom-bust cycle offers evidence that a borrower’s credit quality is tied to their loan default risk, regardless of macroeconomic conditions and changes in home values. An Urban Institute analysis of conventional loan data showed that 2.6% of all Fannie Mae and Freddie Mac loans originated during the expansionary period of 1999 to 2004 defaulted. This share doubled among borrowers with credit scores of 700 or less.
The pattern repeated itself from 2005 to 2008 as the housing-market bubble inflated and burst. Default rates for the conventional borrower population as a whole hit roughly 11% but jumped to more than 20% among sub-700 borrowers.
Still, as the mortgage market severely contracts — Fannie Mae forecast a $2 trillion year-over-year decline in total origination volume in 2022 — there’s a question worth asking: Will lenders expand the credit box to find new business? Goodman thinks it’s possible.
“Mortgage originators have been so capacity constrained that I would argue it’s a good thing that they work a little bit harder with the marginal borrower who can get approved,” she says. “Obviously, you’re not going to work with a borrower you can’t get approved, but certainly working with borrowers who can get approved, that require a little more effort, would be a good thing.”
A clear path to closing more loans without additional risk is to help consumers improve their credit. CreditXpert data shows that this process doesn’t have to take a lot time either. In analyzing 21.2 million credit inquiries during the year ending this past May, the company found that 73% of consumers with sub-760 scores could improve by at least 20 points within 30 days by completing a customized action plan.
In relation to well-known mortgage programs, 53% of consumers below 580 could achieve that target within a month, pushing them over the threshold to qualify for a Federal Housing Administration loan with a 3.5% downpayment. And 38% of those below 620 could improve quickly to meet the minimum score for a conventional loan.
“From a lender perspective, absolutely, it would be really beneficial for them to work closely with that applicant,” Darne says. “Consumers are actually out ahead of things from what we found in our research. It’s about how do we get them connected with mortgage lenders early on so that they can come to the table in the best possible situation?” ●