Is Another Mortgage Crisis Coming Soon?

According to FHFA data, loans to borrowers with low credit scores have about six times the delinquency rates as borrowers with high scores. Should we be worried about lower credit standards?

Jul 20, 2014 at 1:44PM

According to recent data from the FHFA's monthly Foreclosure Prevention Report, nearly 4% of the 28 million mortgage loans owned by Fannie and Freddie are in some stage of delinquency.

While this sounds like a lot, and it is (about 1.1 million loans), the more troubling statistic is the impact of borrowers' credit scores on the delinquency rate. The report indicates that borrowers with low original credit scores have an incredibly high rate of mortgage delinquency, even more than you might expect.

Foreclosure Flickr Respres

flickr/respres

Since many lenders have relaxed their credit standards this year, should we be worried about loose credit standards causing another real estate crash?

The data look pretty bad
Basically, the FHFA's report breaks borrowers into just two credit categories: those whose credit score (when the loan was originally issued) was 660 or above, and those who obtained their mortgage with scores lower than 660.

The vast majority of current borrowers (almost 90%) fall into the higher credit score category, and of that group only 2.6% of loans are in any stage of delinquency, and less than 1.5% are seriously delinquent (over 90 days).

However, of the more than three million loans whose borrowers started with lower credit scores, an alarming 14.4% are in some stage of delinquency, with more than 7% seriously delinquent (which are rather likely to turn into foreclosures or short sales).

Seeing data like that makes me think: maybe we shouldn't be loosening our credit standards.

But bear in mind...
Of these delinquent loans, you have to bear in mind that many were made during the real estate bubble of the 2000's. There is a right and a wrong way to do almost anything, and subprime lending is no exception.

In the current market, it's nearly impossible to get a traditional mortgage with a credit score below 620, or an FHA loan with a score below 580. However, this hasn't always been the case.

A lot of the delinquent loans were made with little or no down payment, with little or no documentation, and to borrowers whose credit scores were well under what is considered acceptable today. There was a time during the last decade when virtually anyone with a pulse could qualify for a mortgage, regardless of credit, income, or cash in the bank.

For a humorous (and somewhat frightening) trip down memory lane, take a look at these actual commercials for mortgages from before the crash. Or, how about this 2005 print ad from Chase Bank, offering mortgage loans with nothing but a signature. These are some of the loans that make up the bloated delinquency rate, even several years after the bubble burst.

Should we be worried?
Not yet, but the trend back toward mortgages for lower-credit borrowers is definitely worth keeping an eye on.

Wells Fargo, for instance, has lowered its minimum credit score for conventional financing from 660 to 620, and for FHA financing from 640 to 600.

However, in order to qualify for a loan with a low credit score, you'll be required to come up with a sizable down payment of at least 20%, pay a higher interest rate, and have a rock-solid employment history.

As I said a minute ago, there is a right way and a wrong way to do things, and until we start hearing things like "no money down, even with a 575 credit score", as in one of those old mortgage commercials, we should be all right.

The housing market needs subprime borrowers to create enough demand for homes, and with lenders acting responsibly, things are very different this time around.

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