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Add Jobs: Adopt Reasonable Credit Requirements for Residential Mortgages

The Great Recession is over, but we are still short on jobs.  In responding to the Realtors® Confidence Index NAR members indicate that credit standards continue to be unreasonably tight.  The level of home sales appears to be held back by artificially tight credit standards.  The data suggest that we could have up to an additional 850,000 home sales per year  if credit standards were at the level used in the 2005/06 time frame—a prudent level of risk and mortgage availability.  That would translate to an additional 425,000 jobs—a simple, no-cost fix that would help the economy.

What does this mean for Realtors®?  Many financial institutions still have excessively high credit requirements for getting a mortgage—apparently as a result of the Great Recession and weakened loan portfolios.  Being turned down for a loan may simply mean that the client applied to the wrong bank—one with a weak loan portfolio.  In the current credit environment, persistence in looking for a loan as well as broadening the search to include credit unions and local and regional banks may yield results.

Mortgage Credit Requirements Have Been Too Tight

The Federal Reserve’s April 2012 Senior Loan Officer Opinion Survey on Bank Lending Practices provided a comparison of current lending policies with those that prevailed in 2006—a time of normal credit markets before the housing crisis.  Responses indicated that credit is tighter for lower FICO score individuals.

In addition, the Office of the Comptroller of the Currency’s yearly Survey of Credit Underwriting Practices reports on lending standards and credit risk.  The 2012 Survey reports that 65 percent of the banks reported unchanged residential real estate underwriting standards; however, 25 percent tightened credit in the 12 months ending February 2012 in comparison to 10 percent who eased credit requirements—on top of already tightened standards.

How Do We Know that Banks are Still Too Risk Averse?

In 2005 approximately 43 percent of Fannie Mae’s and Freddie Mac’s loans went to applicants with credit scores above 740.   Current Relators® Confidence Index data shows that 55 percent of residential real estate loans have FICO scores above 740.  According to the RCI report, approximately 70 percent of residential buyers obtain a loan, and the market in recent months has been in the neighborhood of 4,500,000 homes per year, resulting in a yearly rate of   3,150,000 mortgages.  If the 55 percent of mortgages above FICO 740 were reduced to 43 percent, a back-of-the envelope calculation suggests approximately 850,000 additional homes  per year could be sold if credit markets were more normal.

The Conclusion:  Ease Credit Standards, Increase Home Sales, More Jobs

If banks adopted the credit standards of 2005/06 in making loans, we could expect to see additional home sales of up to 850,000 per year, along with the creation of an additional 425,000 jobs—for home sales generate jobs.  For this to happen, bank regulators would need to convince lending officers that lending portfolios would be evaluated based on normal credit conditions—not the risk averse underwriting practices resulting from the Great Recession.

In the meantime, obtaining a mortgages may continue to be challenging for people with less than perfect (but still well able to pay) credit.  Although mortgage credit requirements have eased slightly in recent months, persistence in finding a mortgage continues to be key for many clients.

Jed Smith, Managing Director, Quantitative Research

Jed Smith is Managing Director, Quantitative Research with the National Association of Realtors®. He has worked on real estate issues for the past 20 years, providing input on a variety of housing, commercial real estate, tax, and planning issues. Recently he has been involved in several international studies.

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