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Tight Lending Is Choking Nascent Housing Recovery

The housing recovery has achieved liftoff, but it won't reach escape velocity until tight-fisted banks loosen tough lending standards put in place after the worst housing crisis since the Great Depression.

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The latest signs of strength came from Tuesday's numbers on housing starts for October, which hit the highest rate in more than four years. Construction began at a seasonally adjusted annual rate of 894,000 units — at 3.6 percent gain — to hit the highest level since July 2008 when the housing bust was in full swing.

(Read More: Good News Keeps Coming for Housing as Starts Surge.)

"It's clear that the homebuilding recovery is gathering a real head of steam," said Paul Diggle, a housing economist at Capital Economics.

Super Storm Sandy, which slammed the East Coast in late October, had little impact on the numbers; the Northeast accounted for about 8 percent of overall housing starts.

The homebuilding data followed a report Monday showing that sales of existing homes also perked up in October, by 2.1 percent to a seasonally adjusted annual rate of 4.8 million units. Though some of the hardest-hit markets haven't yet joined the recovery, prices are also rising again in most regions.

The long-overdue turnaround in the housing market follows the historic collapse that dragged the U.S. economy into the worst recession since the 1930s.

Rising prices are helping to spur demand among buyers who had been waiting for signs that the worst of the price collapse had run its course.

The supply of unsold homes, once glutted by a huge inventory of properties seized in foreclosure, has fallen along with the pace of new foreclosures. The inventory of existing homes has fallen by more than 20 percent in the past year to about 5.3 months' supply, at the current sales pace. That's the lowest level since the market was booming in late 2005.

The housing recovery is also being spurred by an improved job market, which has helped halt the erosion of home ownership, as younger buyers feel more secure about forming new households. The latest Census data show that some 1.2 million new households were formed in the 12 months ending in September, the highest rate in six years.

The revival of the housing market also comes as the Federal Reserve's four-year effort to push money back into the busted real estate bubble finally seems to be paying off.

The Fed recently renewed its strategy to target housing as part of its plan to boost overall growth. In September, the central bank said it will buy $40 billion in mortgage-backed securities per month until the job market shows more convincing signs of recovery.

That flood of cash has further depressed returns for investors, prompting more of them to move cash into real estate. Strong demand from renters has brought healthy increases in monthly rents and sparked a boom in rental housing. In October, starts for multifamily homes surged 11.9 percent to a 300,000-unit rate.

(Read More: Yes, Housing Starts Surge, But Rentals Are the Drivers.)

As investors have returned to the market, all-cash buyers now make up nearly 30 percent of all home purchases, roughly double the levels seen in a healthy housing market, according to the National Association of Realtors (NAR).

But millions of homebuyers who rely on credit to buy a home are shut out, according to Ronald Peltier, CEO of HomeServices of America, a real estate brokerage firm.

"(Tight credit) is eliminating a lot of buyers from the marketplace who are creditworthy people — sincere, earnest Americans wanting to buy a home," he told CNBC. "They're just kept out of the market."

For borrowers, the first hurdle is coming up with a down payment; many lenders insist on 20 percent of the home's purchase price. Though the median down payment fell in 2012, it remains far above what it was during the housing boom, when nearly half of first-time buyers made no down payment at all.

About three out of four first-time buyers tapped into savings to come up with that down payment; one in four relied on a gift from a friend or relative, typically their parents, according to the NAR.

But scraping together a down payment won't get your loan approved. Most lenders insist on a FICO credit score of 720 or higher. During the housing boom, a "prime" borrower needed a 680 score or better. Many subprime lenders all but ignored credit scores.

The housing bust demonstrated how much financial damage was caused by widespread lending abuses.

So it made sense for lenders to raise credit standards after the bubble burst, Fed Chairman Ben Bernanke told a housing advocacy group last week.

"However, it seems likely at this point that the pendulum has swung too far the other way, and that overly tight lending standards may now be preventing creditworthy borrowers from buying homes, thereby slowing the revival in housing and impeding the economic recovery," Bernanke said.

Homebuilding is expected to add to the growth of gross domestic product growth this year for the first time since 2005.

By itself, the housing industry makes up a relatively small portion of GDP. But the housing industry is an important component of the overall recovery from recession because home sales drive purchases of other goods, like furnishings and appliances.

That spillover effect from the bottoming in housing has helped boost growth, but not nearly to levels seen in past recoveries. Some four years after the recession ended, the growth in gross domestic product, at about 2 percent, is far weaker than in past recoveries.

Despite recent gains, the housing market remains deeply depressed from the boom years of the mid-2000s. Housing starts in October were about 40 percent of their 2.27 million-unit peak in January 2006.

The housing industry's revival has also failed to spur job growth. Despite the recent pickup in new homebuilding, for example, residential construction jobs fell in October to less than 560,000, close to record lows in 1992, according to Michael Dolega, an economist at TD Economics.

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