Mortgages Are Now Just as Risky as They Were During the Early 2000s

A new analysis from CoreLogic reveals that mortgage risk is on the rise and now similar to levels seen in the early 2000s.

The good news is that credit risk isn’t mirroring levels seen in the mid-2000s, right before the flagging housing market ushered in the Great Recession.

The bad news is we’re starting to see mortgages get riskier again, which was inevitable given how very low-risk they were post-crisis.

Why Are Mortgages Getting Riskier?

• Mortgage risk is on the rise
• Thanks to a higher share of home purchase mortgages
• Which present more risk because they involve new credit being extended
• Versus refinances that are often just existing debt with new terms

Well, per CoreLogic, there are a number of reasons why their Housing Credit Index (HCI) is on the rise.

For one, the mix of home loan applications is beginning to slant toward purchases as opposed to refinances, thanks to higher mortgage rates and less incentive to touch your existing loan.

Logically, purchase mortgages present more risk because borrowers are taking on new credit, and in many cases, they are first-time home buyers.

With a refinance, risk often goes down because the borrower tends to lower their interest rate, though if it’s a cash out refinance, risk can rise with the larger loan amount.

The other main reason mortgage risk is increasing is due to a higher share of investor activity and more condo and co-op lending.

Again, if the borrower doesn’t reside in the property, risk goes up. The same goes for condos and co-ops where a number of individuals live in a common building. This explains why rates are higher for condos.

We’re also seeing an increase in lower-documentation lending, though it’s unclear if this is full-blown non-QM lending or stuff backed by Fannie, Freddie, and the FHA.

Higher Rates Lead to Lower Quality Borrowers

• As interest rates rise over time
• Fewer borrowers will want/need a home loan
• This tends to usher in a riskier group of homeowners
• As lenders look for new prospects despite lower credit quality

Another issue affecting credit risk is higher mortgage rates. Well, I should say the risk of higher mortgage rates, since they’re actually still really low.

But pundits have been forecasting rate increases for years now, and at some point, they’ll be right.

Of course, they were up about 0.5% during the first quarter of 2017 from the same period a year earlier.

When mortgage rates rise, fewer borrowers stand to benefit from a refinance. As such, loan officers shift their attention to borrowers who they may have ignored in the past.

These borrowers tend to have lower credit scores, trickier loan scenarios, and perhaps unique properties that are harder to close.

CoreLogic chief economist Dr. Frank Nothaft noted that since 2009, every one-half percentage point increase in mortgage rates led to a nine point drop in the average credit score for refinance borrowers.

He believes this pattern will continue if rates keep rising, as lenders and their employees search under new rocks to find leads.

Overall, the HCI increased to 105.6, up 3.6 points from Q1 2016, which puts it close to the 105.9 number seen from 2001 to 2003. That period was seen as a “normal baseline for credit risk.”

The year-over-year rise was muted thanks to improved borrower credit scores, loan-to-value ratios, and DTI ratios that remained steady, despite higher home prices.

Q1 2017 Mortgage Risk Highlights

• Average credit score up 7 points year-over-year to 741
• Share of home buyers with credit scores below 640 was less than 3%, compared to 25% in 2001
• DTI ratios held steady around 36%
• LTVs dropped by 1.7% from 87.6% to 85.9%
• Share of home buyers with an LTV greater than or equal to 95% was 43%, compared to 29% in 2001.
• Investor share of home-purchase loans increased from 4% to 5% year-over-year
• Condo/co-op share rose from 10% to 12% year-over-year
• Low or no-doc loans increased from 2% to 3% of home purchases year-over-year

In summary, credit scores look good and documentation is still solid. However, we are seeing some high-LTV lending, perhaps thanks to all those 1% down mortgage programs and the 97% LTV programs from Fannie and Freddie.

Additionally, nearly one in four (24%) home buyers had DTIs greater than or equal to 43% in the first quarter, up from 18% in 2001.

As home prices and mortgage rates rise, these numbers could worsen, thereby increasing mortgage risk. But we’re still a far cry from 2006. And that’s great news.