Freddie Mac Housing Outlook Focuses on Vetting Low Down-Payment Loan

It is different this time. rnAt least that’s the contention of the writers of this month’s Economicrnand Housing Outlook regarding new low downpayment mortgages.  Freddie Mac’s Office of the Chief Economist,rnwhich publishes the report says that the company’s Home Possible Advantage mortgage,rnintroduced in March, is a very different product than similar loans that wererncommon before the housing crisis. </p

The mortgage, which permits a reduced downpayment of asrnlittle as 3 percent and allows the funds to be a gift from family or employersrnor a grant from a government agency, has raised concerns that mortgage lending mayrnbe returning to some of the risky lending practices that led to the housingrncrisis.  Low downpayments and thernresulting low levels of equity left many who bought homes in the middle part ofrnthe last decade to sink rapidly underwater when home prices declined,rnespecially in cases were home values were based on what Freddie Mac calls “overlyrnoptimistic appraisals.”  </p

Lack of equity led to increases in lender losses whenrnborrowers defaulted and indeed being upside down left homeowners with less incentivernto honor their mortgage obligations.  Itrnis undeniable, Freddie Mac says, that reduced down payments are one of the riskrnfactors that lenders must consider.</p

The report adds, however, that this was not the only or evenrna primary factor that increased mortgage risk in those days. In many cases itrnwas layered risk, i.e. several features which, when combined with lowrndownpayments, multiplied the risk.  Thesernincluded:</p<ul class="unIndentedList"<liVariable payments. Payments changed from their origination amountsrnin cases where adjustable rate mortgages (ARMs) also had initial teaser ratesrnor when borrowers took out interest only or negative amortization loans which laterrnreverted to straight line amortization over shortened terms. Often borrower debt-to-income (DTI) ratiosrnwere based on the low initial monthly P&I payments, not the reset payments thatrnborrowers were then not financially equipped to meet.</li</ul<ul class="unIndentedList"<liProperty-based underwriting. Prior to the crisis lenders anticipated thatrnprices would continue to increase and limit their risk and thus tended to placernless emphasis on qualifying the borrower.rnThis led to approval of borrowers with lower credit scores and higherrnDTI than usual and to such practices as allowing self-verification of incomernand assets. In addition a larger thanrnusual share of loans were made to investors who did not occupy the homes andrnwere quicker to walk away from the loan as home values sank.</li</ul<ul class="unIndentedList"<liQuestionable appraisals. With rapidly rising prices it was difficult forrnappraisers to assess home values. Inrnaddition, appraisal hiring practices made appraisers less independent and morernprone to pressure from real estate agents and loan originators.</li</ul<ul class="unIndentedList"<liBorrower "irrational exuberance." During the boom consumers became more willingrnto stretch financially to purchase a home, increase their leverage throughrnrefinancing, and take on debt they were not equipped to service under terms theyrndidn't understand.</li</ul

Freddie Mac says things are different today.  Payments are predictable in a marketrndominated by fully-amortizing, fixed rate mortgages – the only loan typerneligible for the Home Possible Advantage Program.  Current underwriting standards focus on thernborrower’s ability and willingness to repay the loan rather than the value ofrnthe property.  Borrower qualificationsrnsuch as credit scores and debt-to-income ratios are tighter, income and assetsrnmust be fully documented and cash-out refinances are more tightly controlled.  In some cases pre-purchase counseling isrnrequired. </p

Appraisal practices have been changed to eliminate outsidernpressure on appraisers.  Finally thernhousing crisis has had a sobering influence on borrowers who themselves arernlimiting risk; delaying home purchases until financially prepared and choosingrnplain vanilla fixed-rate loans.</p

In the outlook portion of the monthly report Freddie Mac’s economistsrnsay that the long-running economic recovery remains weak and continues tornsputter.  Economic data showing growingrnstrength – home sales and prices for example – alternate with mixed orrndisappointing signals (weak first quarter GDP growth and stagnant wages.) </p

Instead of the acceleration in real growth, tightening laborrnmarkets, and a slight gain in inflation the economists had predicted at thernbeginning of the year – improvements that could have led to an increase by thernFed of interest rates – the first quarter brought another severe winter in thernNortheast, a West coast dock strike, and negative real growth.  These along with lots of global problems,rnpushed down long term interest rates in the U.S.</p

Freddie Mac predicts the economy to be stronger in thernsecond half, especially the housing sector with real growth up a bit over 3rnpercent.  This will be partially due to arnrecovery from the first quarter and partially because of the Fed delaying anrnexpected June rate hike until at least September.</p

The housing sector will benefit from that delay and FreddiernMay expects housing starts to increase 14 percent and single-family mortgagernorigination by 8 percent.  House pricesrnwill rise by over 4 percent this year which should support an eventual increasernin the supply of homes although inventories will still remain tight.  All of this, however, could be dampened by arncontinuation of the Greek debt crisis or continued financial volatility inrnChina.

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