Over the past few years, lenders, homebuyers, Realtors and refinance borrowers have become increasingly frustrated with the constant and quiet tightening of qualifying criteria for a home mortgage. Loans that were routinely approved a few short years or even months ago are now being denied or put through the ringer before getting approved. It may help to put some historical context to what we are seeing.
The 1970s
The arrival of the federal government-sponsored enterprises (GSEs)—which began purchasing loans from banks and mortgage lenders—opened the world to universal secondary market standards. The first loans purchased by the GSEs required housing debt no greater than 25% and total debt no more than 33% of a borrower’s gross monthly income. A borrower’s credit history could reflect no late monthly payments for the past two years and no late mortgage payments for the past three years. Income was limited to salary from a primary job; bonus, overtime and income from a second job was discounted or ignored. The minimum downpayment was 10% of the sales price.
The 1980s
The growth of Freddie Mac, Fannie Mae and the private mortgage insurance industry resulted in an expansion of credit and innovative mortgage products. Debt ratios expanded to 28/36. Credit required perfect payments for a year, with one or two explainable late payments within two years; mortgages had to have clean payment records for two years. Secondary income sources were allowed with a two-year history. Adjustable rate mortgages (ARMs), graduated payment mortgages (GPMs) and loans with potential for negative amortization were introduced. The minimum downpayment dropped to 5%.
The 1990s
Coming out of a moderate real estate recession in the late 80s and early 90s, the market surged with new confidence. Property values were once again rising and credit became easy. Debt ratios for GSE loans expanded to 33/38. Credit scores replaced credit history; everyone was fine with a 660 minimum credit score for most loans, and a 680 for the new 97% LTV loan. A new market emerged where borrowers who had credit issues or could not verify income, but who still had large downpayments or large amounts of equity, could secure a loan. The subprime credit market was born.
The 2000s
The turn of the century saw the mortgage market turn into the Wild West. Spurred by a decade of 10% plus annual real estate appreciation, investors and lenders attempted to take advantage of a mortgage market where all the risks were mitigated by a few years of property appreciation. There were no longer standard debt ratios. Lenders spoke of a single total debt ratio of 41%, but the automated underwriting systems of the GSEs routinely approved loans with debt ratios above 50%. The new minimum credit score dropped to 620 for conventional loans, with no minimum scores required for some subprime mortgages. Purchase loan programs were offered at 100% LTV and subprime equity take out second mortgages were offered at 125% LTV. Adjustable rate mortgages with low first year (teaser) rates were combined with payment caps and negative amortization to create a new exotic mortgage product called the Option ARM. Loans were introduced that no longer required income or asset verification. Mortgage brokers bragged that with the wide range of conventional and subprime options, there was a mortgage for everyone regardless of income or credit.
The Crash
Once owner occupancy in the U.S. reached record highs and it seemed everyone had a home and a mortgage, the demand for housing that had for years exceeded supply slowly turned upside down. By 2006 all markets in the U.S. were experiencing declines in property values, and unqualified, ill-prepared homebuyers were losing their homes to foreclosure. This caused a ripple effect in the economy: unemployment rose to double digits and qualified borrowers who were now unemployed or underemployed and unable to sell their homes were going into default and foreclosure.
Post-Crash
The GSEs, investors and insurers have all tightened their standards. This is entirely appropriate since it is clear that standards were far too lax in the years leading up to the crash. For anyone whose homeownership experience has been limited to the last decade or so, today’s standards can seem very harsh. In reality, conventional lending standards are more like they were in the 1980s. It is more difficult to get a loan than it was in the early 2000s, but it is still a bit easier than it was in the 1970s.
What have we learned?
The last 30 years have seen a steady infusion of capital into the mortgage lending market—both from investors and from the GSEs—as well as gradual but consistent easing of standards. All of this was designed to make homeownership accessible to more and more people. We were reminded in a very stark way that real estate markets, like all markets, are cyclical and that home prices do not rise indefinitely.
It is still possible for banks to make good loans and it is still possible for homebuyers to get a loan. MassHousing, for instance still offers loans with as little as 3% down. The important thing is that each loan must be appropriate for each homebuyer. After the shock of the financial crisis in 2008, it was only natural that there would be a dramatic swing away from the generous lending by the big national lenders. As time goes on, we should see some easing of standards, enough so that the housing market once again achieves equilibrium.