Today some fear that the real estate market will start to look a lot like in 2006, just before the house crash. One of the factors they point out is the availability of mortgage money. Recent articles about the availability of low-prepayment loans and prepaid assistance programs are causing fear that we will return to the bad habits seen 15 years ago. Let’s alleviate these concerns.
Several times a year, the Mortgage Bankers Association publishes an index entitled The Mortgage Credit Availability Index (MCAI). According to their website:
“The MCAI provides the only standardized quantitative index that is only for mortgage credit. The MCAI is … a summary measure that indicates the availability of a mortgage loan at a time. “
Basically the index determines how easy it is to get a mortgage. The higher the index, the more available a mortgage loan becomes. Here is a graph of the MCAI dating back to 2004, when the data were first available:As we can see, the index was around 400 in 2004. Mortgage credit became more available as the domestic market warmed, and then the index passed 850 in 2006. When the real estate market fell, so did MCAI (below 100) because mortgage money became almost impossible to secure. Fortunately, lending standards have eased slightly since then. However, the index is still below 150, which is about a sixth of what it was in 2006.
Why was the indexman furious over control during the house bubble?
The main reason was the availability of loans with extremely weak loan standards. To keep up with the demand in 2006, many mortgage lenders offered loans that placed little emphasis on the borrower’s qualification. Lenders have approved loans without always going through an audit process to confirm whether the borrower is likely to be able to repay the loan.
Some of these loans offered attractive, low interest rates that have increased over time. The loans were popular because they could be obtained quickly and without the borrower having to provide documentation beforehand. However, as rates rose, borrowers struggled to pay off their mortgages.
Today, lending standards are much stricter. How Investopedia explains, the risky loans granted then are extremely rare today, mainly because lending standards have drastically improved:
“After the crisis, the U.S. government issued new regulations to improve standard lending practices across the credit market, which included tightening lending requirements.”
An example of the loose lending standards before the house crash is the FICO® credit score associated with a loan. What is a FICO® score? The website myFICO explains:
“A credit score tells lenders about your credibility (how likely you are to repay a loan based on your credit history). It is calculated using the information in your credit reports. FICO® Scores are the standard for credit scores – used by 90% of major lenders.”
During the residency, many mortgages were written for borrowers with a FICO score less than 620. Experian reveals that, in today’s market, lenders are more wary of lower credit scores:
“Statistically speaking, 28% of consumers with credit scores in the Fair range will likely be seriously offended in the future … Some lenders dislike those odds and choose not to work with individuals whose FICO® Scores fall into this range.”
It is certainly still loan programs which allow 620 score. However, lending institutions are generally much more careful about measuring risk when approving loans. According to Ellie Mae latest Original Understanding Report, the average FICO® score on all loans incurred in February was 753.
The chart below shows the billions of dollars in mortgage money given annually to borrowers with a credit score of less than 620.In 2006, mortgage institutions generated $ 376 billion in loans for buyers with a score of less than $ 620. Last year that number was just $ 74 billion.
In 2006, lending standards were much more relaxed with little appraisal done to measure a borrower’s potential to repay his loan. Today standards are stricter, and the risk is reduced for both lenders and borrowers. These are two very different housing markets, so there is no need to panic about today’s lending standards.
Content previously posted in Keep Current Things