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Mortgage Risk Index Hits New All-Time High


You’d think that risk would be pretty low at a time when mortgage guidelines are tight and housing is finally recovering. But you’d be wrong, if you believe the data from the American Enterprise Institute’s National Mortgage Risk Index (NMRI).

The NMRI measures how newly originated loans would perform (their default rate) if subjected to the same stress present in 2007.

Their data includes loans acquired or backed by Fannie Mae and Freddie Mac, along with FHA and USDA loans.  They plan to add VA loans in the near future, as well as refinance loans and loans without government backing.

Per the AEI, an index value below six percent is deemed “stable,” and they estimate that the index value in 2007 would have 19%.

Last month, the risk index for home purchase loans hit a new series high of 11.89%, up from 11.50% in March.

Of course, it should be noted that the index only dates back until August 2013, so yes, it all sounds a lot more dramatic than it probably is.  Still, it has risen steadily since starting out at 10.61% back in August.

FHA Loans Are Apparently Very Risky

total dtis

The latest monthly rise was linked to a large increase in FHA loans, which the AEI, and more specifically, Edward Pinto, doesn’t seem to like very much.

He’s the same guy that late last year referred to the FHA as a predatory lender, arguing that low-risk borrowers are steered to the FHA when they could qualify for cheaper conventional loans.

In April, the FHA’s home purchase volume jumped 36% compared to March, whereas Fannie Mae and Freddie Mac’s April home purchase volume only rose 24%, and was actually down four percent from March 2013.

As a result, mortgage default risk keeps on rising. Loans backed by the FHA and Rural Housing Service (USDA) exhibited a mortgage risk reading of 25.1% last month, compared to just 5.9% for Fannie/Freddie loans.

FHA loans are more risky for several reasons. For starters, 35% of FHA’s home purchase loans have FICO scores below 660. Additionally, many are tied to homes in riskier areas, such as California’s Central Valley.

The FHA also allows loans with as little as 3.5% down with high DTI ratios, whereas Fannie and Freddie got rid of their 3% down loans late last year.

In short, if we face another massive downturn, the FHA loans in the high-risk, fringy areas will probably be the first to go into default.

Risk Buckets Paint a Clear Picture

risk buckets

But all loans are displaying elevated risk, with half having a down payment of five percent or less (a number that is rising), and nearly a quarter with DTI ratios above 43%, which is the Qualified Mortgage limit.

Simply put, the QM rule isn’t doing all that much to deter risk, as I noted a couple weeks back. The lack of an LTV limit or minimum credit score keeps things fairly loose.

In fact, low-risk loans (stressed default rate of less than 6%) accounted for just 41.8% of April activity, down from 46.4% back in August 2013.

At the same time, home prices in the third quarter of 2013 were already considered 18% overvalued in real terms, per Fitch Ratings, and since then home prices have just climbed higher.

Overall risk in the housing market is also on the rise, with John Burns Consulting giving the housing-cycle risk a rating of a “B-” as of March. That’s compares to a rating of “A/A-” in December 2012.

Additionally, 27 metros in California now have a “C+” rating, meaning if lenders keep loosening guidelines as home prices begin to peak, we could repeat history a lot sooner than we ever imagined.

(photo: Stuart Caie)

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