The Future of the Secondary Market: A Straight, Broad Highway to Debt-Free Ownership for Low-income and Minority Home

Buyers
March14, 2014
Presented by

David H. Stevens
President and Chief Executive Officer Mortgage Bankers Association

Your Logo here

Presented by Edward Pinto Codirector--International Center on Housing Risk American Enterprise Institute

The views expressed are those of the author alone and do not necessarily represent those of the American Enterprise Institute.

Lets start with what we can agree on:

Homeownership rate differences among minorities and whites are worthy of national discussion, as are potential solutions. According to the Census Bureau, the homeownership rates for NonHispanic Blacks (Blacks), Hispanics, and Non-Hispanic Whites (Whites) are 43.2 percent, 45.5 percent, and 73.4 percent respectively. Credit is a key input into the ultimate sustainability of any loan and the stability of both neighborhood and national housing markets.
The credit profile for these groups is vastly different.
A 2007 Federal Reserve report to Congress on credit scoring found that the median scores for Blacks, Hispanics, and Whites were 618, 670, and 737 respectively (medians interpolated from the Fed data). The same report found credit scores to be predictive of credit risk for the population as a whole and for all major demographic groups and further credit characteristics included in credit history scoring models do not serve as substitutes, or proxies, for race, ethnicity, or sex.

Blacks and Hispanics are expected to account for well over half of the growth in households from 2010 to 2025.
2

Contentious Issues: Duty to Serve and Disparate Impact

View: narrow underwriting prevents low-income and minority borrowers from getting loans to the same extent as higher income/non-minority ones. The same argument led to the 1992 affordable housing goals.
Gail Cincotta (1991 Senate Banking testimony): "Lenders will respond to the most conservative standards unless [the GSEs] are aggressive and convincing in their efforts to expand historically narrow underwriting."

But the QM credit box is broad, deep, and pro-cyclical during a boomall FHA (and Fannie and Freddie) are eligible (see Appendix 1 (580+ FICO).
Risk Bucket
Very Low Low Medium

FICO
770 720-769 690-719

CLTV
61-70% 76-80% 81-85%

DTI
33% 34-38% 39-43%

Default Rate
0.8% 4.2% 9.3%

High
Very High

660-689
620-639

91-95%
> 95%

39-43%
39-43%

21.95%
37.7%

Note: Default rates represent cumulative defaults through year-end 2012 for Freddie Macs 2007 vintage of acquired loans. The loans included in the calculation are all primary owneroccupied, 30-year fixed-rate, fully amortizing, fully documented, home purchase loans.

3 Investor loans, HELOCs, and mandated mods add more fuel during a boom.

A Thought Experiment

To raise Black and Hispanic homeownership rates to the White rate of 73.4 percent would require the origination of 10 million 30 year loans totaling $1.7 trillion with an

average credit score of 630, a downpayment of 3.5 percent and a median debt-to-income ratio of 42%.
These loans clearly present high risks to homebuyers, neighborhoods, lenders, mortgage insurers, and taxpayers.

A second thought experiment

A home loan with a 630 FICO, 4% downpayment and 43% DTI. FHAs advantages and cross subsidies allow substantial underpricing compared to the private sector.
12% rate on a private 30 year fixed rate loan (rate based on Barclays data) with a loan constant of 12.34clearly a high risk loan.
Amortized LTV after year 5 94%.

4.25% rate on an FHA 30 year loan with 1.75% upfront MIP and 1.35% annual MIP with a loan constant of 7.25clearly still a high risk loan.
This is due to fact that the reduced loan constant was allowed to be fully capitalized into a 67% higher home price. Amortized LTV after year 5 89%.

An alternative:
Allow the FHA home buyer to purchase a 32% higher priced home by reducing the term to 15 years, the rate to 3.25%, and the MIP to 0.65% (loan constant = 9.15).
This dramatically reduces risk to the borrower and neighborhood. Amortized LTV after year 5 70%.
5

Insanity: doing the same thing over and over again and expecting different results Albert Einstein
FHAs failed effort to serve lower-income borrowers in the 1960s

and early-1970s was chronicled in Cities Destroyed for Cash.

The affordable housing mandates contained in the 1992 GSE reform act did not end well.

Duty to Serve and Disparate Impact in the context of the procyclical QM credit box would have the same result: Increased leverage bidding up the price of existing housing, less affordable housing, and volatile home prices for those least able to cope. Mortgage has become just another word for troubleinstead of a straight, broad highway to debt-free ownership for families with the ability, desire and discipline to become homeowners. (FHA 1935)
6

Appendix 1: Periodic Table of Risk