A new paper raises concerns that mortgage-lending standards — after becoming dangerously lax during the housing bubble — could now lock out qualified, entry-level homeowners, leading policymakers and industry officials to learn the wrong lessons from the housing bust.
The paper is co-authored by Lewis Ranieri, the co-inventor of the mortgage-backed security, who addressed the annual convention of the Mortgage Bankers Association on Monday. Ranieri argues that poorly constructed loan products — rather than extending loans to working-class borrowers — was the main cause of the housing bust.
“In response to the excesses of the bubble period, we are step-by-step creating a reformed system with near zero tolerance for risk,” wrote Ranieri, along with co-authors Kenneth Rosen, Mark Goldhaber and Andrew Lepcio.
Federal mortgage data show that this is already having a disproportionate impact on households with less wealth, particularly African-American and Hispanic borrowers. Figures for new loan applications and originations “look more like the America of the 1950s, and not the America of 2013,” the authors write.
So how should policymakers correct course? Ranieri and Co. lay out a series of fixes for any new housing-finance regime. Here are six:
1. Homeownership (and mortgage lending) should focus on building equity. Homebuyers, they argue, should be educated on buying a slightly smaller home with lower payments, or a loan with a faster amortization schedule, that allow them to build equity more quickly. During the bubble, the “forced-savings” nature of a 30-year fixed-rate mortgage often became turned on its head, as borrowers made payments that deferred any amortization or as they took cash out of their houses by refinancing into larger loans as home prices rose.
2. Home-equity mortgages — or second mortgages — need more strings attached. The owner of the first-lien should have the ability to approve a second mortgage and the ability to take equity out of a house with a second mortgage should be limited to money used for “life events” such as a health-care crisis or a college education. “Simply put,” they conclude, “education YES, a 50-inch flat screen TV NO!”
3. The mortgage market needs to overhaul the process of what’s known as “servicing,” by which companies collect payments on behalf of investors. Typically, most mortgages are sold off by the initial lender, and a “servicer” — sometimes that initial lender — will process payments on the loan investors’ behalf. Servicers make the same amount of money if a loan is performing or if it’s delinquent, even though delinquent loans are much more expensive to manage. This caused massive problems during the boom. The authors suggest building in functions for different servicing companies to take on loans that become delinquent — a model employed in the commercial real estate world.
4. Regulators will need to implement rules that allow for more flexibility in determining a borrower’s ability to repay a loan. New rules set to take effect next year could lead to an overcorrection that substitutes strict rule-following for more traditional underwriting. For lenders that do extend loans to borrowers with lower credit scores — say, below 620, which was once considered “subprime” — borrowers should be required to complete a “full-cycle education program with debt and budget counseling.” Such education should be available to all borrowers.
5. Policymakers should focus more attention on home-rental programs that provide renters with an “option to own.” These programs would give borrowers with less-established credit histories a mechanism to build their credit and savings to purchase a home after a long, stable period of responsible rentership.
6. Finally, the authors argue in favor of maintaining healthy securitization markets, where large amounts of loans are pooled together and then sold off to investors. The authors argue against a move toward “risk-based” pricing, which they say accomplishes the opposite of what securitization was initially intended to do — to smooth out regional and other differences in borrowing costs.
Source: MSN Real Estate