The Mortgage Credit Crisis

The Mortgage Bankers Association just reported that “credit availability reached its lowest level since 2014”. It’s going in the wrong direction, but it’s going to get a LOT WORSE because of new government policy soon to be implemented. Essentially, if an aspiring homeowner has less than 10% down payment; and/or a credit score at 680 or under; and/or debt to income projections at a certain percentage (45%) – “the government” will limit the amount of loans with these characteristics that government agencies - Fannie Mae and Freddie Mac - can buy from lenders of America to 6% of their total business. That’s not a misprint, it’s 6% - not 60%! Nearly every first-time homebuyer in America will hit 2 or all three of those new benchmarks. It’s the first time in history those kinds of restrictions will be imposed. In January, 2021 “the government” created these new restrictions on the aspiring homeowners of America. The restrictions begin to take effect in the middle to later part of 2021 and don’t have an “end date”. Unless “the government” takes corrective action – these new restrictions are here to stay. 

It’s hard for most people to imagine that “the government” plays a key role in determining availability of mortgage credit. But “the government” does. And for the past ten years or so, ever since the Great Recession, government policies limiting access to mortgage credit have been going ballistic!

Let’s start with a short history lesson. The Great Recession of 2005-2012 came about because “the government” wasn’t paying attention to its responsibility to protect consumers from predatory and abusive practices in the mortgage market. Things went haywire. But so much of the crisis – which by the way – cost single family homeowners $7 Trillion of aggregate loss in home values between 2006 and 2011– could have been mitigated or maybe stopped in its tracks if “the government” would have done its job. To be more specific – when lenders and Fannie Mae and Freddie Mac were going crazy, allowing mortgage loans to be made to virtually anyone who could fog a mirror, “the government” could have stopped the madness in its tracks by simply demanding that Fannie Mae and Freddie Mac be prohibited from buying any mortgage loans (made by lenders) that were not fair, responsible, well underwritten, fully documented and sustainable. It would have been an easy mitigation “stop sign”…lenders couldn’t make bad loans if they didn’t have anywhere to sell them. But “the government” failed and the failure consumed America.

The crisis had already blown up America and the world-wide investor market (investors buy most of the mortgage loans in America through the purchase of Mortgage Backed Securities) when “the government” finally decided to pass the Dodd-Frank Act in July, 2010 to – you guessed it - require that all mortgage loans in America be fair, responsible, well underwritten, fully documented and sustainable. 

If “the government” would have taken action at any time in the 5 years prior to 2010 – the crisis might have been mitigated. 

So what’s happened since 2010? America has mostly recovered from the Great Recession – mortgage interest rates have fallen to their lowest level in history – but the rate of homeownership in America has stalled and in the case of the Diverse Segments of America – is virtually no better than it was in 2010. In fact, in the case of African Americans, the rate of homeownership has fallen to its lowest level since the Civil Rights Act of 1964. 

Do you wonder why? It’s mostly because of “the government” continuing to tighten credit to a point where it’s severely debilitating opportunity. Here are two examples:

1. Since 2008 “the government” has allowed Fannie Mae and Freddie Mac (Fannie and Freddie) to “double-charge” certain consumers for the same risk. First, every mortgage loan made by a lender and sold to Fannie and Freddie where the borrower has less than 20% downpayment must have Private Mortgage Insurance to mitigate the risk to Fannie and Freddie. The cost of that insurance is paid for by the borrower. But since 2008, in addition to the Private Mortgage Insurance, Fannie and Freddie have charged consumers additional fees called “Loan Level Price Adjustments” to mitigate the same risk they already have insurance to protect. Any way you cut it – it’s a “double charge” for the same risk. And – as you may suspect – it disproportionately affects the aspiring homeowners in the diverse segments – but punishes nearly every consumer with less than 20% downpayment. The “government” seized Fannie and Freddie in 2008. They are still under government control. This “double-charge” is happening under the “watchful eye” of “the government”.

2. The Federal Reserve Bank of New York just reported that the median credit score on mortgage loans in 2020 was 786 and that 70% of mortgages granted were to people with a credit score of 760 or above, up from 61% in 2019. Much of this is due to lenders tightening credit availability – imposing certain “credit overlays” on consumers with lower credit scores (that means charging more in fees or rate) – and lenders responding to the government restrictive policies noted above. As a reminder – when a lender makes a conventional loan to a consumer that has less than 20% down payment – the lender almost always covers the majority of their risk by requiring the borrower to obtain Private Mortgage Insurance. When a lender makes a FHA loan to a consumer, the FHA covers nearly 100% of the lender risk by issuing FHA insurance (paid for by the borrower). When a lender makes a VA loan to an eligible borrower, the VA covers a major share of the lender risk.  So if you’re wondering – why the aggressive credit tightening when the risk to lenders seems minimal? There are many answers to that – but one big answer is – the government wants more profits for the government entities where most of these mortgage loans are sold…Fannie Mae and Freddie Mac. More fees, more revenue, more profits for these government agencies at the expense of opportunity for aspiring homeowners. By the way, Fannie Mae and Freddie Mac made approximately $20 BILLION of net income in 2019. That figure will be undoubtedly higher in 2020.

The aspiration for homeownership in America is at an all-time high. Mortgage rates are at all-time lows…but “the government” involvement in credit policy has made it “all-time” difficult to obtain financing. The only thing that will change this harrowing trend – is the voice of the people.