It is different this time. At least that's the contention of the writers of this month's Economic and Housing Outlook regarding new low downpayment mortgages. Freddie Mac's Office of the Chief Economist, which publishes the report says that the company's Home Possible Advantage mortgage, introduced in March, is a very different product than similar loans that were common before the housing crisis.
The mortgage, which permits a reduced downpayment of as little as 3 percent and allows the funds to be a gift from family or employers or a grant from a government agency, has raised concerns that mortgage lending may be returning to some of the risky lending practices that led to the housing crisis. Low downpayments and the resulting low levels of equity left many who bought homes in the middle part of the last decade to sink rapidly underwater when home prices declined, especially in cases were home values were based on what Freddie Mac calls "overly optimistic appraisals."
Lack of equity led to increases in lender losses when borrowers defaulted and indeed being upside down left homeowners with less incentive to honor their mortgage obligations. It is undeniable, Freddie Mac says, that reduced down payments are one of the risk factors that lenders must consider.
The report adds, however, that this was not the only or even a primary factor that increased mortgage risk in those days. In many cases it was layered risk, i.e. several features which, when combined with low downpayments, multiplied the risk. These included:
- Variable payments. Payments changed from their origination amounts in cases where adjustable rate mortgages (ARMs) also had initial teaser rates or when borrowers took out interest only or negative amortization loans which later reverted to straight line amortization over shortened terms. Often borrower debt-to-income (DTI) ratios were based on the low initial monthly P&I payments, not the reset payments that borrowers were then not financially equipped to meet.
- Property-based underwriting. Prior to the crisis lenders anticipated that prices would continue to increase and limit their risk and thus tended to place less emphasis on qualifying the borrower. This led to approval of borrowers with lower credit scores and higher DTI than usual and to such practices as allowing self-verification of income and assets. In addition a larger than usual share of loans were made to investors who did not occupy the homes and were quicker to walk away from the loan as home values sank.
- Questionable appraisals. With rapidly rising prices it was difficult for appraisers to assess home values. In addition, appraisal hiring practices made appraisers less independent and more prone to pressure from real estate agents and loan originators.
- Borrower "irrational exuberance." During the boom consumers became more willing to stretch financially to purchase a home, increase their leverage through refinancing, and take on debt they were not equipped to service under terms they didn't understand.
Freddie Mac says things are different today. Payments are predictable in a market dominated by fully-amortizing, fixed rate mortgages - the only loan type eligible for the Home Possible Advantage Program. Current underwriting standards focus on the borrower's ability and willingness to repay the loan rather than the value of the property. Borrower qualifications such as credit scores and debt-to-income ratios are tighter, income and assets must be fully documented and cash-out refinances are more tightly controlled. In some cases pre-purchase counseling is required.
Appraisal practices have been changed to eliminate outside pressure on appraisers. Finally the housing crisis has had a sobering influence on borrowers who themselves are limiting risk; delaying home purchases until financially prepared and choosing plain vanilla fixed-rate loans.
In the outlook portion of the monthly report Freddie Mac's economists say that the long-running economic recovery remains weak and continues to sputter. Economic data showing growing strength - home sales and prices for example - alternate with mixed or disappointing signals (weak first quarter GDP growth and stagnant wages.)
Instead of the acceleration in real growth, tightening labor markets, and a slight gain in inflation the economists had predicted at the beginning of the year - improvements that could have led to an increase by the Fed of interest rates - the first quarter brought another severe winter in the Northeast, a West coast dock strike, and negative real growth. These along with lots of global problems, pushed down long term interest rates in the U.S.
Freddie Mac predicts the economy to be stronger in the second half, especially the housing sector with real growth up a bit over 3 percent. This will be partially due to a recovery from the first quarter and partially because of the Fed delaying an expected June rate hike until at least September.
The housing sector will benefit from that delay and Freddie May expects housing starts to increase 14 percent and single-family mortgage origination by 8 percent. House prices will rise by over 4 percent this year which should support an eventual increase in the supply of homes although inventories will still remain tight. All of this, however, could be dampened by a continuation of the Greek debt crisis or continued financial volatility in China.