Two major changes in the mortgage market go into effect this month, and both could help millions more borrowers qualify for a home loan. The changes will also add more risk to the mortgage market.
First, the nation's three major credit rating agencies, Equifax, TransUnion and Experian, will drop tax liens and civil judgments from some consumers' profiles if the information isn't complete. Specifically, the data must include the person's name, address, and either date of birth or Social Security number. A sizeable number of liens and judgments do not include this information and have subsequently caused some misrepresentations and mistakes.
Of about 220 million Americans with a credit profile, approximately 7 percent have liens or civil judgments against them. With these hits to their credit removed, their scores could go up by as much as 20 points, according to a study by credit rating firm Fair Isaac Corp. (FICO).
"It's a significant impact for still a very large number of people," said Thomas Brown, senior vice president of financial services at LexisNexis, who is concerned that the move will add significant risk to the mortgage system.
"If you look at someone that has a tax lien or a civil judgment, they can be anywhere from two to more than five times more risky just because of the presence of that information," he said. "That's very, very significant."
Credit reports, however, can have mistakes on them that end up sidelining consumers from qualifying for loans. Twenty percent of consumers have at least one mistake on one of their three credit reports, according to a Federal Trade Commission study. The concern is that those who do have legitimate liens and judgments against them will get credit that is undeserved.
"It doesn't really do a consumer well to be extended credit that they can't afford, they can't reasonably service," said Brown.
In addition to the FICO changes, mortgage giants Fannie Mae and Freddie Mac are allowing borrowers to have higher levels of debt and still qualify for a home loan. The two are raising their debt-to-income ratio limit to 50 percent of pretax income from 45 percent. That is designed to help those with high levels of student debt. That means consumers could be saddled with even more debt, heightening the risk of default, but the argument for it appears to be that risk in the market now is unnecessarily low.
"In this case, we're changing the underwriting criteria, and we think the additional increment of risk for making that change is very small," said Doug Duncan, Fannie Mae's chief economist. "Given how pristine credit has been post-crisis, we don't feel that is an unreasonable risk to take."
During the last housing boom, anyone with a pulse could get a mortgage, but after the financial crisis, underwriting rules tightened significantly. As a result, current default rates on loans made in the last eight years are lower than historical norms. At the same time, younger borrowers with high levels of student loan debt are being left out of the housing recovery, unable to qualify for a home loan. Duncan said a consumer's debt level is just one of many factors considered by lenders when underwriting a mortgage.
"We look at all the other criteria that are information rich, in terms of assessing that individual's risk profile, and they have to look good in all those other areas," he added.
The level of risk to the mortgage marketplace, banks and nonbank lenders alike, will rise. Fannie Mae and Freddie Mac are still under government conservatorship, which means losses would be incurred by taxpayers.
"Is Fannie taking on more risk than they should by going up to a 50 percent DTI limit? Those are legitimate questions that the [Consumer Financial Protection Bureau] or Congress should be answering," said Guy Cecala, CEO of real estate trade publication Inside Mortgage Finance.
And all these changes come at a time when lenders are competing for a shrinking market of borrowers. Higher interest rates have meant far fewer mortgage refinances, and high home prices have resulted in fewer homebuyers. In response, lenders expect to ease other credit standards further. In fact, those expectations reached a record in the second quarter of this year on a Fannie Mae lender survey. The study noted that easing credit standards might be due in part to increased pressure to compete for declining mortgage volume.
"For the third consecutive quarter, the share of lenders expecting a decrease in profit margin over the next three months exceeded the share with a positive profit margin outlook. For the former, the percentage citing competition from other lenders as a reason for their negative outlook reached a survey high," Duncan wrote in the report.
Fannie Mae also noted in its announcement of the DTI changes that its appetite for risk remains the same. That may mean a shift in other parts of a borrower's risk profile.
"There is the belief that there is this windfall for consumers, that consumers will just be able to get more credit," said Brown of LexisNexis. "Well, the reality is the risk in the marketplace has not changed. The information that's used to assess risk is what's changing, and so for banks and others extending credit, if they want to maintain the same loss rates, they have to tighten credit somewhere else. It's just pure math."