Are Strict Mortgage Standards Holding Back the Housing Market?

Housing America's FutureAre strict mortgage lending standards holding back the housing market? That’s the theory proposed recently by a commission consisting of key players from the mortgage and housing industries.

The 2013 report, entitled “Housing America’s Future: New Directions for National Policy,” was published in February by Bipartisan Policy Center. It suggests that mortgage standards in the U.S. may have become overly strict over the last few years.

During the housing boom, lending standards went the other direction, becoming overly lax. Back then, nearly anyone could qualify for a home loan. But when the housing market crashed, mortgage lenders retrenched and tightened up their lending criteria. Which leads us to the report published last month.

The report is based on insight and commentary provided by members of the housing commission. The commission included key executives from the financial industry, including the president of the American Bankers Association. There were also several academics and policy group leaders on the commission. View the full list of members.

Mortgage Standards Have Become ‘Overly Strict’

The central theme of the report was this: Home sales are likely to stay below historic levels as a result of overly strict mortgage lending standards. The commission pointed to three factors, in particular, that are restricting lending volume and slowing growth within the housing industry.

“Sales of new and existing homes remain well below historic levels going back several decades. Observers attribute the decline in home sales, in part, to unnecessarily rigid down payment, debt-to-income, and credit score requirements that were imposed in the aftermath of the housing market’s collapse.” –Housing America’s Future: New Directions for National Policy

Credit score requirements

Is it possible for a three-digit number to derail a mortgage loan, even if the borrower is qualified in other regards? If that number is your credit score, the answer is yes.

Credit scores are a risk-assessment tool. Mortgage lenders use them to measure the level of risk a borrower brings to the table. A high score indicates a person who has repaid all of his/her debts in the past. A low score generally indicates a person with a history of missed payments, delinquencies or defaults. So the credit score can be a useful tool during the mortgage lending process.

But the report’s authors are concerned that some lenders are putting too much emphasis on the credit score, to the point of ignoring the borrower’s “overall creditworthiness.”

Debt-to-income ratios

This is another number with the power to make or break a mortgage loan, all by itself. As the name implies, a debt-to-income (DTI) ratio is a numerical comparison between the amount of money a person earns each month, and the amount they spend on recurring debts. In this context, recurring debts can include car payments, credit cards, student loans, and the mortgage loan itself.

In 2013, many mortgage lenders are limiting borrowers to a total or “back-end” DTI ratio no greater than 43%. In fact, we did a story recently about how this number is emerging as a trend in the mortgage lending world.

Here again, the Housing Commission expressed concerns that mortgage lenders are putting too much emphasis on debt ratios as a make-or-break qualification criteria. This certainly jives with the anecdotal reports we’ve heard from borrowers in 2013.

Down payment requirements

Down payments have been in the news a lot lately. The so-called Qualified Residential Mortgage (QRM), a forthcoming regulation affecting the mortgage industry, has raised fears the government will impose a standard down-payment requirement for all borrowers.

The report’s authors call for the use of “reasonable down payments” that will “open the door to homeownership and its benefits for individuals with modest wealth and incomes.”

In all of these areas, the Housing Commission’s recommendations were the same. They argue we should restore the “appropriately conservative” lending standards that were used before the housing bubble changed everything. They recommend that mortgage lenders should put an emphasis on the overall creditworthiness of each individual borrower.

In their call-to-action at the end of the report, the authors state that we need “A responsible, sustainable approach to homeownership that will help ensure that all creditworthy households have access to homeownership and its considerable benefits.”

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