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Will High Quality Mortgages Prevent Another Housing Bubble?


After the previous mortgage boom and subsequent crash, many questions were asked regarding what exactly went wrong.

There was plenty of finger pointing, from overreliance on credit scores, to endless investor speculation, to Wall St. packaging substandard mortgages and the government’s accommodative policies.

But one source of blame that kept resurfacing was the prevalence of high-risk loan products, such as the option arm.

Others blamed “subprime” for the housing crash, though that infamous eight-letter word was often used as a one-size-fits-all definition for any mortgage that went bad.

Regardless, it was clear that shoddy mortgages held some material amount of blame for the previous crisis.

After all, many of the loans were destined to fail, seeing that the teaser rates offered were the only way one could afford the property to begin with.

Today’s Mortgages Are Pristine

If you want to compare the previous housing run-up to that of today’s, you should consider the mortgages behind the properties being purchased.

Back during the mid-2000s, the quality of mortgages was awful. Scores of homeowners were purchasing properties with credit scores well below 620, which is the subprime cutoff.

Additionally, these borrowers were purchasing homes with zero down financing, or worse, with zero documentation. Not to mention many of the properties were non-owner occupied four-unit properties, often with second mortgages stuck at 12%.

One of the most common loan documentation types was stated income, which allowed borrowers (or their loan reps) to put any amount of monthly income they’d like in the box on the application.

This was all good and well in the eyes of pretty much everyone because it banked on home prices soaring ever higher, despite already chalking massive gains.

The idea, in short, was that it didn’t matter if the borrower was sound if the property was expected to surge in value.

At worse, the borrower could refinance again or sell (for a profit) if they couldn’t keep up with their mortgage payments. We all know how badly that ended…

Just a few short years later, the quality of mortgages has done a complete 180. The average credit score for newly originated loans is north of 700. Additionally, average LTVs have dropped, meaning borrowers have home equity in case something goes wrong.

If anything, LTVs are going to keep dropping as bidding wars force new homeowners to put more down in order to get their offers accepted.

At the same time, more and more borrowers are opting for long-term fixed-rate mortgages, and with mortgage rates are at or near record lows, it makes for a pretty solid bet (even Buffett backs it).

The low rates are good for the housing market because it means homes are more affordable in payment terms, and it also means many previously stuck with higher rates can refinance.

Even those with underwater mortgages have benefited, thanks to HARP 2.0, which erased the LTV ceiling.

Yes, there will be consequences of this quantitative easing down the road, but for now, quality mortgages are being originated at rock-bottom rates.

And some banks are even compensating their loan officers based on loan quality, as opposed to loan volume.

Is This a Housing Boom or a Mortgage Boom?

You almost have to question whether this is a play on housing, or a play on getting a mortgage at a ridiculously low rate.

If mortgage rates were closer to historic norms, would prospective home buyers have the same voracious appetite?

My guess would be no, seeing that home prices have already returned to fairly high levels in many parts of country.

In fact, they aren’t too far off their previous bubble highs in some regions, meaning the low rates must be part of the equation.

Still, if and when rates do rise, it doesn’t mean home prices will plummet like they did before. It will probably result in a cooling off period, but that doesn’t equate to a bubble bursting.

[Mortgage rates vs. home prices]

The reason most people lost their homes or walked away during the previous crisis was due to a lack of home equity (and down payment), coupled with an unsustainable housing payment.

Today’s borrowers are a lot more qualified and invested, holding mortgages they can truly afford. This makes owning long term a lot more attractive, even if home prices have shot up recently.

These homeowners will be able to sit tight and enjoy their low, low fixed housing payments, even if home prices bounce around a bit. Why walk away from that?

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