Dana Wade, the acting Federal Housing Administration commissioner, minced few words in testimony last month before a U.S. House of Representatives committee.
The FHA, the federal housing agency that insures mortgages made to first-time and lower-income buyers, has seen "certain trends and indicators of potential defaults," Wade said.
The number of FHA-insured borrowers who are behind on mortgage payments has jumped, Wade wrote in her testimony. The use of down payment assistance is up. The frequency of FHA borrowers who are spending more than 50 percent of their income on debt payments has increased, too. And the number of borrowers refinancing their homes to take cash out for other uses has swelled.
"Some of this increase may be attributable to a decrease in mortgage credit quality," Wade warned. "Indeed, lower credit quality is a concern for FHA because it hampers borrowers' ability to withstand adverse events."
During the hour-long hearing in front of the bipartisan housing subcommittee, however, none of the eight representatives who volleyed questions at Wade acknowledged her lending concerns even once.
After years of tight credit in the aftermath of the Great Recession, both conventional mortgage lenders and the FHA have been easing credit standards — allowing for low down payments, for example, or higher levels of borrower debt — to lure first-time and low- to moderate-income buyers back to the housing market, industry observers say. By making it easier for these groups to obtain mortgages, the observers argue, it is only natural to see a modest uptick in missed payments — especially by FHA borrowers — after almost seven years of steadily dropping delinquency rates.
Not all market observers are convinced that these changes are OK. As federally sponsored mortgage giants Fannie Mae and Freddie Mac, as well as the FHA, have introduced these easier credit requirements to promote more homeownership, some critics worry that the mortgage industry could be headed toward dangerous territory if it continues to become easier to get a mortgage — especially amid what Edward Pinto, a fellow at the conservative think tank American Enterprise Institute, currently calls the "Housing Boom 2.0." By allowing borrowers to take on more debt or put less money down on a house in today's super-charged real estate market, observers such as Pinto argue, lenders could be setting themselves up for higher rates of borrower default in the event of a recession — something that Pinto believes is not too far off.
"For every time there is a boom and a correction, the group that gets hurt the most are low-income and minority home buyers, in general, because they are the ones using the most leverage when house prices are going up," Pinto said. "… House prices are growing rapidly, and we can't predict how high that boom will go, and we can't predict when the turn will come — all we can say is we're in [a boom], and the longer it goes on, the more painful the correction will be."
The split between observers on the issue reflects just how difficult it is to craft a sweet-spot of mortgage lending requirements in this ultra-hot real estate market. In contrast to critics such as Pinto, observers such as the Urban Institute, a left-leaning think tank, argue that allowing more imperfect buyers to enter the market — ones with bruised credit scores or little savings — is an "important step" to increasing access to mortgages for buyers who have been shut out of the housing market. In particular, with Fannie Mae announcing last year that it would support loans for buyers who have a debt-to-income ratio of 50 percent, up from its previous 45 percent ratio, the Urban Institute estimates that 95,000 more loans will be approved annually — a large portion of which will go to black and Latino buyers.
(A debt-to-income ratio measures how much of a borrower's gross income will be spent on a mortgage and other debt payments. Freddie Mac, Fannie's smaller sibling, also allows for a 50 percent debt-to-income ratio. While neither Fannie nor Freddie is a lender itself — and instead purchases mortgages from lenders to keep money moving through the market — the standards they set largely influence the decisions that banks and other agencies make.)
For observers such as the Urban Institute, however, expanding access to mortgage credit is more than just policy — arguing instead that it can affect livelihoods. By restricting mortgages to borrowers with only pristine credit scores or little debt, they say, lenders can deprive low- to middle-income people from the opportunity to accumulate wealth through home ownership. And as a whole, they contend, it can hold the economy back from a robust recovery.
In response to such concerns — and amid increasing competition — lenders have begun increasing access to mortgages. Nearly four years ago, in one of the first major industry shifts, both Fannie Mae and Freddie Mac announced they would allow buyers to put down as little as 3 percent on a home — a reduction from the previously required 5 percent down, and a serious reduction from the 20 percent requirement that regulators floated after the Great Recession. (For a $200,000 home, a 3 percent down payment would be $6,000.)
Despite allowing for such small down payments, both mortgage backers said borrowers are still required to obtain private mortgage insurance, have a credit score that can be as low as 620, and provide documentation of their financial history. Some borrowers also are required to participate in online home-ownership counseling.
"When you read these guidelines, [lenders] are not doing this across the board without taking certain precautions," said Frank Nothaft, chief economist for CoreLogic, a real estate data company. "No one can get a 3 percent down loan with a 50 percent debt-to-income ratio … and [bad credit.] There have to be other features in loan applications that mitigate risk."
To be sure, observers such as Nothaft add, the current easing of today's requirements is nowhere near where it was a decade ago. Leading up to the recession, lenders were allowing borrowers to provide no documentation of their finances and granting loans with no money down.
"I'm seeing more scrutiny," said Colleen Flynn, a real estate agent for Berkshire Hathaway HomeServices Fox & Roach in Newtown Square, who worked on the banking side during the last housing boom. "We have no no-documentation loans anymore … no interest-only loans, where borrowers weren't paying down their principal. … I'm not seeing [lenders] throwing money at people."
Indeed, Flynn said she has seen today's lender scrutiny up close. One of her clients, 26-year-old Brittney Whitehead, who has been searching for her first home, has struggled to find a lender who will overlook her credit score, which she said was dinged after she failed to pay a bill that she said she never received in the mail.
She's a ninth-grade teacher who owes more than $66,000 in student loans and has only modest savings. And while she hopes to put around 3.5 percent down on an FHA loan for a house she found in Delaware County for $132,500 — one where she hopes to raise her newborn son with her fiancé — she is waiting to hear whether her mortgage is approved.
Since the rollout of those low-down payment programs by Fannie and Freddie, banks including Wells Fargo and Bank of America have joined the 3 percent down payment trend. Many lenders have resumed allowing borrowers to use gifts or other assistance to contribute to the down payment, too.
The FHA allows borrowers to put as little as 3.5 percent down.
Most recently, Freddie Mac launched a new program, HomeOne, that still allows borrowers to put down 3 percent, but does not come with any kind of geographic or income restrictions — similar to the FHA. In addition, Freddie Mac has been working to find ways to better underwrite loans for the self-employed, a category of borrowers who struggle to access loans due to difficulty providing financial documentation.
For 36-year-old Nickolas Brozek, the managing partner of two Philadelphia restaurants, including Dim Sum House on the 3900 block of Chestnut Street, anxiety over documentation for a mortgage was one of the things that held him back from buying a house years ago.
As a partner in the food industry, Brozek said, his income fluctuates largely with restaurant profits. Checks vary in regularity — and size. Plus, having entered the workforce right before the recession, he said, he was hesitant to apply for a credit card during his 20s — and instead relied heavily on cash he picked up from bartending out of school. He waited to get his first credit card until he was 30.
"Everyone I knew out of school had so much credit card debt, and since I worked in a cash environment, I just decided to pay cash for everything," Brozek said. But the lack of credit accumulation finally hit him when he started thinking about buying a home.
"Is my credit OK?" Brozek said he asked himself. "Am I going to be able to qualify?"
Thanks to having little debt accumulation and an annual salary of more than $100,000, Brozek said, he was able to qualify for an FHA loan earlier this year despite his modest credit and sporadic documentation. He opted to put 3.5 percent down on a new home in Kensington, which he bought for $311,000.