Expanding the credit box: What's wrong and how to solve it

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As the mortgage industry moves farther past the housing crisis, access to credit remains tight, especially for first-time homebuyers.

The mortgage industry is taking half, possibly even less than half, of the risk it was taking in 2001 and 2002, according to Laurie Goodman, center director at the Urban Institute, who was among panelists speaking at the Mortgage Bankers Association’s National Secondary Conference in New York.

But, "loans now are currently performing better — with any given set of credit characteristics — than ever before," said Goodman.

For first-time homebuyers, access to credit is particularly difficult. Many first-time buyers have low to no credit score but still have a clean history of paying their rent or car loans on time.

And regarding the Federal Housing Administration, which captures the riskier borrowers, there are two main issues preventing better access to credit.

First, servicing FHA loans is significantly high, as it costs about 3% more than the typical expense to service a loan. The second main problem concerns the False Claims Act.

Under the False Claims Act, financial institutions are subject to pay triple in damages if any errors are found. And once an investigation is underway, any inaccuracy, no matter how small, becomes eligible for the False Claims Act.

The act never applied to these institutions until 2007, and the problem became bigger than the monetary payout, as the reputation risk was arguably more of a threat to banks than the financial one. Because of this, many bank lenders have retired from the market, resulting in more than 80% of FHA lending being conducted by nonbanks.

To solve some of these issues, the industry could implement the defect taxonomy, which will provide clarification on the underwriting errors that can expose lenders to triple damages.

Also, revamping FHA servicing may be in order. Making due diligence timelines more flexible, by having one timeline for the entire process, and reforming the conveyance process are two ways to help alleviate challenges and more safely expand the credit box, according to Goodman.

Another way to approach expanding the credit box is to analyze the composition of the market.

The current homeownership rate of younger families shows a significant drop in levels compared to those between 2001 and 2008. While there are typically 1.8 million first-time homebuyers in the market in an average year, there are 3 million first-time buyers "missing" from the market since 2008 as that number has fallen, according to Tian Liu, chief economist at Genworth Mortgage Insurance.

"If we can get back to a homeownership rate that's comparable to historical levels, then we could basically erase over the overcapacity problems," said Liu.

First-time homebuyers don't typically have much saved up for a home purchase, making low down payment programs imperative to keeping them in the market. But, even with these, younger buyers in particular struggle to show proper credit history when they are perfectly capable of making on-time payments.

To approach this, the industry can make better use of alternative credit. More frequently utilizing bank statements to show defect rental history and referencing cellphone and utility bills can help serve as indicators of creditworthiness.

The industry can also call for more use of manufactured houses, which are higher quality than they once were and cost much less than traditionally built new construction homes. With starter home inventory especially low, manufactured houses will not only create more supply, but they will create more supply in price brackets that first-time homebuyers can afford.

Another method supporting better access to credit involves having less rigid rules for measuring income, which will allow consumers with less stable job history to prove their ability to pay for a mortgage, according to Goodman.

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Credit scores Credit quality First time home buyers False Claims Act Risk management Risk appetite Housing inventory Mortgage Bankers Association FHA