In the aftermath of the Great Recession, protections were put in place to eliminate bad mortgages. Lenders became much more demanding of who could qualify for loans, and laws were passed to ensure that the global economy would never again collapse due to dangerous lending.
However, fears are growing over the return of riskier loans.
House prices continue to reach new levels and mortgage interest rates are also rising rapidly. According to Realtor.com, this is causing some loan officers to relax their lending standards — albeit a little — to keep their pipelines nice and fat. Buyers are already outdoing themselves financially to win bidding wars, and more and more borrowers are choosing mortgages that start out cheap but get more expensive over time.
It is a strange echo of the mounting financial crisis.
“Lending standards in today’s housing market are up and down compared to the housing boom of the mid-2000s, in part because of the regulations put in place after the stock market crash,” said Ali Wolf, chief economist of the Zonda construction consultancy. “While tougher lending rules are in place, the combination of rising house prices, rising mortgage interest rates and rising inflation is straining home buyers in today. Anecdotally, we hear from some loan officers that homebuyers are starting to stretch out just to be able to secure a home.
Homebuyers are facing mortgage payments that are about 50% higher per month than a year ago for the same home, due to the double whammy of rising house prices and rising mortgage rates.
Buyers have reacted by pushing their budgets to the limit, which can be dangerous if they don’t leave themselves a cushion for rising costs, savings for emergencies and a little extra money to go out or take a vacation. . Inflation also drives up the cost of basic necessities, ranging from a gallon of milk to a gallon of gasoline.
That’s why more and more borrowers are considering adjustable rate mortgages, or ARMs. These loans initially offer cheaper payments with a lower interest rate that can increase over time. About 8.2% of all mortgage applications were for ARMs in the week ending June 3, according to the Mortgage Bankers Association. This is more than double the 3.9% of all applications in the week ending June 4, 2021.
“Anytime people consider adjustable rate mortgages…there’s a risk involved,” said Sarah Mancini, an attorney at the National Consumer Law Center. “Most people’s income does not fluctuate with interest rates. … [And] people are not good at reading these very complicated things [lending] documents. »
These rising rates are also causing lenders to scramble to find new business. More and more buyers are being shut out of the market and many homeowners aren’t as eager to refinance their existing loans now that rates have jumped. Mortgage applications fell 53.6% from a year ago in the week ending June 3, according to the MBA. As a result, lenders give loans to applicants with lower credit scores and more debt.
Lenders are stressed by income, said David Stephens, CEO of Mountain Lake Consulting, who is also a former CEO of the MBA and Commissioner of the Federal Housing Administration during the Obama administration. “They just need more loans in the hopper to stay alive,” he said.
In April, borrowers had a median FICO score of 735, according to data provided by the Urban Institute. Although this is considered a “good” score, it is down from the “very good” score of 761. The debt-to-income ratio increased to 39% in April 2022 from 35% in April 2021.
Most lenders want borrowers to have a FICO score of 580 or higher and a debt-to-income ratio no higher than 43%. Unlike the mid-2000s, they require full documentation to verify that borrowers are making as much money as they claim to be in order to prevent borrowers from being unable to repay their loans.
“Some protections have been put in place following the last foreclosure crisis, but they are not a silver bullet,” Mancini says. “Everyone thought subprime lending wouldn’t come back, [but] there’s no reason to think he can’t or won’t. Perhaps it is market conditions that lead to this.