Mortgage bankers are intensifying scrutiny on applicants’ credit scores, according to the Zillow Mortgage Access Index (ZMAI). The ZMAI measures the tightness of mortgage credit based on the credit scores for the bottom percentile of mortgages originated to fund home purchases. The higher the ZMAI, the lower the credit score required to obtain a mortgage.
Measured since 2002, the ZMAI bottomed out in September 2010 during the depths of The Great Recession, the point at which mortgage credit was the tightest. In 2012, the bottom ten percent of successful homebuyers — those on the cusp of not receiving a loan — had an average credit score of 712. Average credit scores gradually dropped to 670 by the end of 2014, driving the ZMAI figure up.
However, the first year-over-year decline in the ZMAI in three years occurred one year ago, during Q2 2015 (the most recent quarter of data). This slight though significant shift in the ZMAI shows the credit scores for these borderline homebuyers increased to an average of 676.
Is this upward shift in homebuyer credit scores and the accompanying tightening of mortgage credit a sign of market manipulation by lenders? Possibly it’s a reaction to the circumstance of an improving economy providing opportunities with less risk? More likely it is due to home prices rising far faster than wage increases driving out financially weaker buyers who cannot or do not want to compete.
Tightening mortgage credit and home sales volume
A tighter mortgage market is primarily the product of rising fixed rate mortgage (FRM) rates. Higher FRM rates lead to a lower buyer purchasing power index (BPPI), and within 12 months, to lower home prices. As FRM rates consistently rise to further tighten the mortgage market, home prices will flatten to meet and more closely run with the rate of consumer inflation. With fewer mortgage originations in tandem with fewer participating homebuyers, home sales will fall — but we are not there just yet in 2016
To what extent is the year-over-year rise in the credit scores of borderline homebuyers due to mortgage originator scrutiny?
It is possible lenders do not mean to emphasize credit scores when providing loans to borderline homebuyers. As the economy improves in the wake of the housing crisis, so too do the credit scores of potential homebuyers and with them mortgage credit score averages.
However, mortgage originator reaction is not limited to the whims of the recovering economy. Lenders, in tightening access to mortgage credit, insure themselves against future defaults, done when they believe we are in for a turn for the worse.
Lenders need not unreasonably lower mortgage origination standards to favor those who are otherwise unable to afford a mortgage. The problem for real estate sales is that a tightening mortgage market causes stagnation by driving down sales volume, mortgage originations and eventually pricing – until the sales momentum returns to the market.
Mortgage bankers are aware their actions may negatively impact the wider economy, but this is a societal concern of governments, not lenders driven by egos and ever greater earnings.
Mortgage originators as opportunists
Mortgage originators have four possible motives for increasing credit score underwriting scrutiny:
- they have learned the lesson of The Great Recession and have eschewed risky behavior (unlikely);
- they expect FRM rates to rise (2008 hopeful thinking continues);
- they are striking back at post-recession regulations, increasing their risk premium in their rates to influence government policy (likely); or
- the uncertain global market and low mortgage rates are causing them to panic, as they expect weak economies in the coming years (forward thinking, really?)
Lenders are profit-driven to the point of behavior harmful to their long-run well-being — a lesson from the Greenspan years. In most situations they float with the ebb and flow of the economic tide, and as a consequence, experience great highs and great lows. Where they find short-term ways to push the envelope or protect their hides, they do so until, like bad pilots, they are grounded.
Institutional mortgage lenders – Wall Street bankers – exhibit a healthy dose of paranoia at the prospect of what they see as an uncertain future for their present business model. In part, these bankers do not take kindly to the idea of buying back bad mortgages (their mantra is “privatize profits and socialize losses”). So they strike back at regulators where they can and by any available means, trying to regain territory they staked out through deregulation since the 1980-1982 recessions.
In 2018, sales volume will begin to pick up in earnest, peaking in 2019-2021. Then, California will once again see home prices jump beyond the rate of consumer inflation. Mortgage lenders with an eye for fast and easy profits will loosen their lending standards to whatever extent federal regulators permit or their lawyers divine. The memory of the grim mid-2000s will be politely pushed aside, and past mistakes repeated by most participants – lenders, builders, brokers and buyers. For short-term property owners, it will be a time to cash out.
Assisting clients with borderline credit
Mortgage scrutiny will intensify as Wall Street lenders fret about what the future holds. Meanwhile, homebuyers needing purchase-assist mortgage funding who are at the cusp of the credit score cutoff still have options:
- wait, while actively improving their credit and savings; or
- obtain a costly Federal Housing Administration (FHA)-insured mortgage on the purchase of a low-tier priced home.
While the standards for FHA-insured mortgages will be relaxed as the nation’s economic tide rises, they will remain easier but more expensive to obtain than conventional mortgages.
Agents can use some first tuesday tools to enlighten and encourage clients in need of credit score education:
- FARM: 5 things you should know about your credit score
- FARM: Is an FHA mortgage right for you?
- FARM: Applying for a mortgage?
- RPI Form 230 — Credit Analysis Worksheet.