Dana Wade, the acting Federal Housing Administration (FHA) commissioner, minced few words in testimony last month before a U.S. House of Representatives committee.
The FHA, the federal housing agency that insures mortgages made to first-time and lower-income buyers, has seen “certain trends and indicators of potential defaults,” Wade said.
The number of FHA-insured borrowers who are behind on mortgage payments has jumped, Wade wrote in her testimony. The use of down payment assistance is up. The frequency of FHA borrowers who are spending more than 50 percent of their income on debt payments has increased, too. And the number of borrowers refinancing their homes to take cash out for other uses has swelled.
“Some of this increase may be attributable to a decrease in mortgage credit quality,” Wade warned. “Indeed, lower credit quality is a concern for FHA because it hampers borrowers’ ability to withstand adverse events.”
After years of tight credit in the aftermath of the Great Recession, both conventional mortgage lenders and the FHA have been easing credit standards — allowing for low down payments, for example, or higher levels of borrower debt — to lure first-time and low- to moderate-income buyers back to the housing market, industry observers say. By making it easier for these groups to obtain mortgages, the observers argue, it is only natural to see a modest uptick in missed payments — especially by FHA borrowers — after almost seven years of steadily dropping delinquency rates.
Not all market observers are convinced that these changes are OK. As federally sponsored mortgage giants Fannie Mae and Freddie Mac, as well as the FHA, have introduced these easier credit requirements to promote more homeownership, some critics worry that the mortgage industry could be headed toward dangerous territory if it continues to become easier to get a mortgage — especially amid what Edward Pinto, a fellow at the conservative think tank American Enterprise Institute, currently calls the “Housing Boom 2.0.”
By allowing borrowers to take on more debt or put less money down on a house in today’s supercharged real estate market, observers such as Pinto argue, lenders could be setting themselves up for higher rates of borrower default in the event of a recession — something that Pinto believes is not too far off.
“For every time there is a boom and a correction, the group that gets hurt the most are low-income and minority home buyers, in general, because they are the ones using the most leverage when house prices are going up,” Pinto said. “House prices are growing rapidly, and we can’t predict how high that boom will go, and we can’t predict when the turn will come — all we can say is we’re in [a boom], and the longer it goes on, the more painful the correction will be.”
The split between observers on the issue reflects just how difficult it is to craft a sweet-spot of mortgage lending requirements in this ultrahot real estate market. In contrast to critics like Pinto, observers such as the Urban Institute, a left-leaning think tank, argue that allowing more imperfect buyers to enter the market — ones with bruised credit scores or little savings — is an “important step” to increasing access to mortgages for buyers who have been shut out of the housing market.
In particular, with Fannie Mae announcing last year that it would support loans for buyers who have a debt-to-income ratio of 50 percent, up from its previous 45 percent ratio, the Urban Institute estimates that 95,000 more loans will be approved annually — a large portion of which will go to black and Latino buyers.
A debt-to-income ratio measures how much of a borrower’s gross income will be spent on a mortgage and other debt payments. Freddie Mac, Fannie’s smaller sibling, also allows for a 50 percent debt-to-income ratio. While neither Fannie nor Freddie is a lender itself — and instead purchases mortgages from lenders to keep money moving through the market — the standards they set largely influence the decisions that banks and other agencies make.
For observers such as the Urban Institute, however, expanding access to mortgage credit is more than just policy — arguing instead that it can affect livelihoods. By restricting mortgages to borrowers with only pristine credit scores or little debt, they say, lenders can deprive low- to middle-income people from the opportunity to accumulate wealth through homeownership. And as a whole, they contend, it can hold the economy back from a robust recovery.
In response to such concerns — and amid increasing competition — lenders have begun increasing access to mortgages.