money.usnews.com | May 12, 2016
By Maryalene LaPonsie
Ten years ago, a storm was brewing in the housing market.
Lenders were handing out mortgages seemingly to anyone who applied, and in many cases, borrowers weren't asked for documentation to prove income. Some institutions rolled out adjustable-rate mortgages that featured teaser rates and were marketed to consumers as loans that could be easily refinanced before the interest rate was scheduled to reset and send payments into the stratosphere.
As buyers clamored for homes, prices surged. But then the economy slowed and the bottom fell out of the housing market. Homeowners were unable to make payments, and sagging values made refinancing or selling impossible. The market crashed in what is widely considered one of the worst recessions to hit the country.
While the economy and home prices have both rebounded, some people have expressed concern we are headed for a repeat housing bubble. As of January 2016, home prices were rising at a rate twice that of inflation, according to the S&P/Case-Shiller U.S. National Home Price Index.
What's more, Fannie Mae and Freddie Mac have unveiled programs to allow first-time homebuyers to make a purchase with only 3 percent down. Plus, some lenders are using alternate credit scores, which may make loans available to those who can't get one under conventional credit scoring methods. Together, these factors may signal danger ahead. "I wouldn't discount it," says John Harrell, a vice president at USAA Bank, about the possibility of another housing crisis. "But I don't see it as an imminent threat."
Government regulations have changed the playing field. Harrell isn't concerned about a housing crisis, in part, because the mortgage industry looks different today than it did in 2006. Most notably, the Dodd-Frank Act was passed in the wake of the recession to eliminate much of the risky behavior that led to the proliferation of subprime loans. The bill prohibited the use of negative amortization and certain balloon payments. It all but wiped out the possibility of lenders using so-called low-doc or no-doc loans that didn't require borrowers to substantiate their income. "The regulatory scrutiny is very high," Harrell says.
Many lenders have also voluntarily tightened up their lending standards and are limiting access to mortgages to only those with very good credit. While subprime mortgages could be found 10 years ago for borrowers with credit scores well below 620, the bar has been raised substantially, says Brad Friedlander, co-founder of Angel Oak Capital Advisors in Atlanta, Georgia. "A bad borrower has a credit score in 2016 that is 100 points more than the bad borrower in 2006," Friedlander says. Nowadays, many creditors are looking for mortgage applicants to have credit scores north of 720.
New down payment options for mortgages cause concern. At the same time as they are tightening certain lending rules, both the government and banks are looking for ways to extend mortgages to those who can't afford or wouldn't qualify for a conventional loan.
Traditionally, Federal Housing Administration loans have provided the most accessible option for those who want to buy a house, but can't afford the down payment. These loans may have only required 2 percent down, but Harrell says many big banks have backed away from offering them.
Without FHA loans, another viable low down payment option for potential homeowners may be a VA loan, which may require zero down. "It's time-tested, and it's a great program," says Harrell. However, not everyone can qualify for a VA loan, so Fannie Mae and Freddie Mac have now begun offering loan programs with down payment requirements as low as 3 percent. At least one borrower on the application must be a first-time home buyer and income requirements and other criteria may apply.
A rush of low down payment mortgages may be reminiscent of 2005 and 2006, but there is no reason to believe they alone will cause a housing crisis. "The fact that people are highly leveraged doesn't mean prices are going down," says Mark Fleming, chief economist at First American.
Alternate credit scores may expand the pool of borrowers. Fleming is also quick to say the use of alternate credit scores shouldn't be worrisome either. Some lenders have begun to look for other ways to gauge a person's credit-worthiness, particularly those people who have limited or no credit under traditional scoring models. "What you need to establish credit-worthiness is changing," Fleming says. "New credit models are reflecting that."
For example, millennials may be renting longer or opting for mobile phones rather than landlines. Old scoring models might not take those factors into consideration, resulting in low or no credit. Alternate models may also be able to address non-traditional situations, such as multi-generational families or those earning income through the sharing economy. "The whole point of these new models is that they are able to score people who would [otherwise] not have a credit score or have a limited one," Fleming says. "But that doesn't mean they are of poor credit score quality."
Reasons to remain optimistic about the housing market. With 10 years between us and the start of the last great housing crisis, many people are feeling optimistic that both lenders and borrowers have reformed their bad behavior. Not only have banks eliminated many risky lending practices, but "most American borrowers tend to be stronger savers now," Friedlander says.
Some people may feel skittish about rising home prices and apparent attempts to open the mortgage market to unconventional borrowers, but many industry experts say there is no reason to believe a repeat of 2006 is about to happen. "House prices have rebounded, and the jobs market looks quite good," Fleming says. "There's not a lot of data indicating another housing crisis."
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