Tighter Mortgage Standards Could Prolong Housing Slump

It’s tougher for people with spotty credit histories to get a mortgage, which could prolong the housing slump.

Prime borrowers who can document their income are still in a good position to secure a mortgage. And while subprime borrowers, or those with weak credit records, comprise a small segment of the housing market, they've driven much of the growth in housing in recent years.

“Even though (subprime) is a small segment, it’s an important segment, especially since the fundamentals within housing are not very strong and the inventory situation is still weak,” said Celia Chen, director of housing economics at Moody’s Economy.com

“I think we have some more pain to endure this year and next,” added Bob Walters, chief economist at Quicken Loans, the online mortgage lender in Livonia, Mich., referring to weak home sales and pricing. “Industry-wide, about 10% to 15% of individuals who could have gotten a loan four months ago can’t get one today.”

Mortgage lenders have tightened their lending standards in response to the meltdown within the subprime mortgage industry. As investors in mortgage-backed bonds--or pools of loans packaged as securities--lost their appetite for subprime-backed securities, mortgage lenders had to follow suit, and stopped making loans to the riskiest borrowers. That, in turn, has shrunk the pool of potential homebuyers in a market where there’s already a glut of inventory.

More Evidence

The Federal Reserve also found more evidence of banks tightening the credit spigot: In its April poll of senior loan officers, the Fed said on Monday that 45% of domestic banks surveyed reported a tightening of mortgage standards for non-traditional residential loans--including Alt-A loans that require little documentation of income --over the past three months. And more than half of the institutions originating subprime mortgages also raised standards for borrowers.

The ripple effects of stricter lending caused the National Association of Realtors to slightly dampen its housing outlook last week for the second time this year.

“If it weren’t for a favorable economic backdrop, housing would probably have a hard landing,” said Lawrence Sun, senior economist at National Association of Realtors, said in a statement. “As it is, we see this as a soft landing with home sales rising gradually in the second half of the year and prices recovering a bit later.”

Existing-home sales are likely to total 6.29 million this year and 6.49 million next year, compared with 6.48 million last year, according to the NAR. New-home sales are projected at 864,000 in 2007 and 936,000 in 2008, down from the 1.05 million sold in 2006. Housing starts should total 1.46 million units this year and 1.52 million in 2008, a decline from 1.8 million last year.

Prices Drop

The national median existing-home price is expected to drop 1.0% to $219,800 this year, and rise 1.4% next year, according to NAR. The median new-home price is expected to be largely unchanged at $246,400 in 2007, but rise 2.2% in 2008.

Investors will get an idea about what builders are thinking about the housing slump when several data points are released this week. The National Association of Home Builders will post its housing market index, which will measure sentiment for May, on Tuesday.

And on Wednesday, the Department of Commerce will release its report on April housing starts, which measures new home construction but tends to be volatile because so much depends on the weather. Data on building permits, an indicator of future construction activity, will also be posted.

“The housing market looked like it was ready to bottom until the problems in the subprime market began to surface,” said Economy.com' Chen. "Because of the timing, that will prolong the housing correction a little bit more. The risks remain on the downside for housing.”

© 2009 CNBC.com