Ask any real estate agent, home builder or home buyer what is the biggest barrier to entry in today’s housing market, and the likely answer will be: tight credit.
The lax lending of the latest housing crash is no more, but some claim the pendulum has swung too far in the other direction.
High credit scores and large downpayments are often required to get the lowest mortgage interest rates, and that is knocking many would-be home owners out of the game.
While some argue that we have just returned to the days of responsible lending, banks are clearly more gun shy due to the billions of dollars’ worth of bad loans that they have been forced to repurchase from Fannie Mae and Freddie Mac.
The two mortgage giants have claimed false “representations and warranties” on thousands of loans sold to them by lenders. (Read More: 'Wind Down of Fannie, Freddie: 'Positive for Housing'?)
The representations and warranties are basically what the lender tells Fannie and Freddie about the loans and the borrowers.
Through the first half of 2012, lenders have had to repurchase a total of $41.95 billion in mortgages from Fannie and Freddie. (Read More: Fannie Mae COE: 'Comfortable' With Decision Not to Slash Mortgage Balances.)
That covers loans made before 2005 and through the second quarter of 2012, according to Inside Mortgage Finance. Actual GSE (Fannie/Freddie) repurchase requests or demands are about double that amount.
Given that, it is no surprise that the banks have tightened lending.
“For the market to reclaim the strength it once had, and to provide a cornerstone for the mortgage market of the future, it is vital we consider ways to improve the representation and warranty model,” said Edward DeMarco, acting director of the Federal Housing Finance Agency (FHFA), Fannie Mae and Freddie Mac’s regulator, in a speech to the American Mortgage Conference in North Carolina Monday night.
To that end, the FHFA has released new guidelines that will go into effect on new loans starting the first of next year. Part of the new “framework,” is relief for lenders from mortgage repurchase obligations on loans where the borrower has made on-time monthly payments for 36 consecutive months. On refinances through the government’s Home Affordable Refinance Program (HARP), that term would be knocked down to 12 months. (Read More: Why Millions of Americans Still Can't Refinance Their Mortgage.)
The new framework also provides faster and more in-depth monitoring of loans by Fannie Mae and Freddie Mac. Apparently new data-collection systems will allow for that. This is an improvement because usually the loans are reviewed only after they have defaulted.
“To the extent that a lender controls the origination process, they determine whether or not they are delivering a quality loan,” said a source close to the matter. “Their behavior will determine whether they get relief.”
Banks have been asking for more clarity in the whole repurchase process, and the FHFA is promising that new framework. This all covers new loans, however, and does nothing to address the still thousands of bad loans in the system made during the housing boom. (Read More: Big Banks Pushed to Outsource Mortgages.)
“The FHFA is trying to get banks to lend, take more risk when they sell these loans to the GSE’s,” said FBR’s Paul Miller. “There is a huge problem with people with lower FICO scores not getting access to credit, so the GSE’s have come under a lot of criticism.”
Will it work?
“This will have minimal impact,” claimed Miller, who points to still huge put-backs in process on legacy loans from Fannie Mae, Freddie Mac and the FHA. Put-back risk is one of, if not the top reason lenders are not loosening mortgage credit availability.
“Our concern remains that these initial [loan] reviews could cause lenders to further tighten underwriting standards for fear of running afoul of FHFA’s standards,” added Jaret Seiberg of Guggenheim Partners, who said today’s announcement of the standards only adds to his worries of a credit crunch in 2013.
Still the FHFA claims lenders asked for more clarification on quality controls and asked for earlier monitoring of loans, and that is what they’re getting.
“Ultimately, better quality loan originations and underwriting, along with consistent quality control, will help maintain liquidity in the mortgage market while protecting the Enterprises from loans not underwritten to prescribed standards,” DeMarco said.
The trouble is, this is not the only issue keeping credit tight. (Read More: US Home Builders Begin to See Credit Thaw.)
The future existence of Fannie Mae and Freddie Mac themselves are still in question, and banks are also facing new regulations under the Dodd-Frank (learn more) law that could complicate lending further and heighten lenders’ exposure to risk. For the mortgage lending business, it is still an uncertain future.
—By CNBC's Diana Olick