Securitized mortgage risk growing as lending practices degrade

Political pressure to lower standards increases

The risk rate for securitized agency mortgages is worsening and lending practices are becoming less safe.

That’s the consensus and the conclusion of the latest monthly update from the American Enterprise Institute’s International Center on Housing Risk.

“Political pressures will likely degrade sound lending practices over time,” said AEI senior fellow Ed Pinto on a call Monday morning. 

The center’s Mortgage Risk Indexmeasures the safety of mortgage lending and uses the default experience of loans originated in 2007 as a benchmark to quantify how new mortgage loans would perform if they were hit with a market collapse on par with the recent crisis.

The index classifies loans as low-risk, medium-risk, and high-risk on a monthly basis at national, regional, and local levels. It covers 85% of all new mortgages and 100% of government-issued mortgages.

All the home purchase loans covered by the NMRI today are qualified mortgages, yet, the center found that half have a down payment of less than 5% and one-quarter have a debt-to-income ratio greater than 43%.

“That’s 24% of all purchase loans that have a debt-to-income ratio greater than the QM limit of 43%, a new series high,” Pinto said.

One in three of FHA’s home purchase loans have a FICO credit score below 660, the demarcation line for subprime credit.

Stephen D. Oliner,a resident scholar at the AEI and a senior fellow at the University of California, Los Angeles Ziman Center for Real Estate said that QM is having no discernible affect as DtI ratios are rising, and he noted with great concern news Monday morning that Carrington Mortgage Services is lowering its minimum FICO threshold to 550.

“This is troubling,” Oliner said.

House-price risk is rising, Pinto noted, and that as of the third quarter of 2013, home prices are “overvalued in real terms by approximately 18% nationally, led primarily by exuberant gains in the West.”

The two noted that indices for Fannie Mae, Freddie Mac and FHA/RHS both hit new highs in February, while the composite index ticked down as FHA’s share eased.

“Risk levels remain higher than is conductive to long-run market stability,” Oliner said.

“To put the February level of 11.6% in perspective, the NMRI for loans originated in 1990, when prudent underwriting standards predominated, was about 6%,” Pinto said. “In contrast, the NMRI for the exceptionally risky 2007 vintage of loans was about 19%.  Consequently, the January level indicates that housing risk is substantially higher today than in 1990, but does not approach the level in 2007 when credit standards were the loosest in many decades.”

They said the risk levels at the federal agencies have risen since August, 2013 as a result of increases in FHA’s share of loans, increases in share of borrowers having FICO scores below 660 at FHA, and increases in the share of loans having a debt ratio in excess of 43% at Freddie Mac and Fannie Mae.

There has also been a jump in the share of loans having a down payment of 5% or less at Fannie Mae.

The Consumer Financial Protection Bureau’s “qualified mortgage” regulations that took effect in January, 2014 have not slowed this trend toward riskier mortgages, as Fannie Mae, Freddie Mac, FHA, and RHS are exempt from key provisions, Oliner said.

The full February NMRI can be read or downloaded here.

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