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Better Days are Ahead for Marginal Home Buyers?

Better Days are Ahead for Marginal Home Buyers?

As the top officials to serve in the new Trump Administration are named and they outline their priorities, the broad outlines of the new government’s housing policies are taking shape.  Further details won’t complete the picture until the weeks follow the inauguration.

Even once they settle into office, some of the policy changes in store—especially reducing and revoking regulations—can take place without Congressional action.  The big issues, however, will require legislation.  Once politics and public reaction cone into play, some changes will be more difficult than others.

For an administration sworn to diminish the role of government, housing is a good place to start.  For the past seven years, three agencies of the Treasury Department, Fannie Mae, Freddie Mac and Ginnie Mae (which buys and securitizes FHA loans), have dominated mortgage markets. Together, these three entities buy about 60 percent of all mortgages.[1]  When they dictate terms on mortgages they will buy, whether the limits on the size of mortgages (loan limits) or underwriting standards and practices they will accept, they wield so much power in the marketplace that their policies are an informal form of government regulation.

The Power of De Facto Regulation

Both Fannie and Freddie also provide automated underwriting software free to lenders, which make it significantly easier to qualify and process applications that will conform to Fannie and Freddie’s standards.   These software programs create an additional level of de facto regulation than can make it more difficult for marginal buyers to get qualified. A good example was Fannie Mae’s and Freddie Mac’s refusal for years to update its version of FICO scores it used or consider alternative models like Vantage because of the difficulty involved with changing its Desktop Underwriter program to take into account alternative scoring methods.   It took pressure from Congress to bring about the changes that finally took place earlier this year.[2]

Good Old Fashioned Regulation

In addition to de facto, regulation, there’s plenty of good old fashioned plain vanilla regulation governing housing finance, especially the Dodd-Frank Act, enacted to cure the ills that caused or contributed to the housing crash in 2006-2007.  The two most controversial provisions were the QM Rule, designed to create a new category of “qualified mortgages” for borrowers with less risk. In practice, it has set a maximum ceiling of 43 percent of monthly debt payments.  For young buyers with student loan debt.

Dodd-Frank also led to the creation of the Consumer Finance Protection Bureau, the agency behind the new “know before you owe” TRID forms that delayed closings a year ago and cost the mortgage industry from $300 to $1,000 in additional costs in additional costs.[3]

Both Republican leaders in Congress, like Jeb Hensarling, chairman of the House Banking Committee and Stephen Mnuchin, Treasury Secretary-designate, have made it clear how they stand on the future of Fannie and Freddie. While Mnuchin favors tuning them into private companies again, Rep. Jeb Hensarling (R-Tex.), chairman of the House Financial Services Committee, wants to go even farther, to eliminate Fannie and Freddie’s government charters within the next five years. Sen. Bob Corker (R-Tenn.) has sponsored a bill to do away with the GSEs altogether.[4]

On Dodd-Frank, Mnuchin plans to get rid of it in the first 100 days.  Hensarling wants to take apart the current law and plans to get it done in the House early next year.[5]

Good News for Marginal Buyers

Changes in store on these two fronts—privatization of Fannie and Freddie and repeal or major reform  of Dodd-Frank regulations will make it easier for millions of prospective buyers to qualify for a mortgage.

These include:

  • Younger buyers with slim credit histories or marginal credit scores;
  • Buyers with high levels of debt, including student loans;
  • “Boomerang” buyers who may still suffer low credit scores even though more than seven years have passed since their foreclosures;[6]
  • Self-employed workers, part-time workers, seasonal workers and other applicants whose employment status, income levels and assets or documentation may not meet Fannie Mae’s and Freddie Mac’s underwriting standards or their automated underwriting software;
  • Buyers who otherwise fall through the cracks because of their credit scores, debt-to-income levels and documentation issues.

When these two changes substantially lower the federal government’s profile in mortgage underwriting and securitization, a vibrant private label secondary market will emerge.  Investors rather than government bureaucrats will determine who gets a mortgage.

Ending federal regulations and the GSEs de facto underwriting standards will have immense impact on the housing markets.  In 2016, overly tight standards killed about 1.1 million mortgages that would have been made if reasonable lending standards had been in place—about 20 percent of all existing homes that were sold that year.  From 2009 to 2014, lenders failed to make about 5.2 million mortgages thanks to overly tight credit. In total, lenders would have issued 6.3 million additional mortgages between 2009 and 2015 if lending standards had been more reasonable, according to a new study from the Urban Institute.

However, marginal buyers will pay a price, and it may be an expensive one.  Lenders and investors will require borrowers to pay for the increased risk that they will incur. As 2017 ends, rates on a 30-year fixed rate mortgage are well over 4 percent.  Should Fannie and Freddie lose their government guarantees, rates on conforming loans will automatically rise one to two percent higher. [7]  Lenders will have to charge marginal borrowers even more to attract interest from investors willing to accept the risk.  Significantly higher rates will raise the size of down payments and limit the amount buyers can borrow.




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