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As housing heads into the critical spring market, credit is finally beginning to thaw. Lenders are increasingly approving low down payment loans, and government sponsored mortgage giant Fannie Mae is buying more of them.
It is a noticeable shift from the last four years, when 20 percent down on a home purchase loan was the only game in the neighborhood.
"In general lenders have been willing to do more than they may have been willing to do in the past," said John Forlines, chief credit officer for Fannie Mae's single family business. "Our requirements have not changed significantly, but other parties taking risk, the lenders and mortgage insurance companies in particular, have been more flexible than they may have been in the past."
Fannie Mae will buy loans with as little as 3 percent down payment, but these loans require private mortgage insurance. During the worst of the housing crash, when the private insurers were sinking under billions of dollars in claims on defaulted loans, that insurance was tough to get.
The only low down payment loan left was through the Federal Housing Administration (FHA)—the government's loan insurer. The FHA took on a huge share of the market, far more than it was ever meant to, and while that helped prop up the mortgage market in the short term, it was not sustainable, and the FHA took on huge losses.
Now, facing a $16 billion shortfall, the FHA has raised premiums and will raise them yet again next month. FHA loans are becoming increasingly expensive.
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Meanwhile, as the housing market improves, private mortgage insurers are starting to remove overlays on higher loan-to-value loans, meaning the percentage of the home value that is mortgaged. Low LTV's and high credit scores were the rule recently for the private insurers, but that may now be loosening, making these loans cheaper than FHA.
"FHA is certainly becoming more expensive," noted Craig Strent, CEO of Apex Home Loans in Bethesda, Maryland. "The increase in low down payments is reflective of first time buyers coming off the sidelines and entering the market. We're going to see more of this trend in the next couple of years as the economy improves and renters start to once again see the benefit of buying over renting. FHA has become more expensive and the mortgage insurance companies are the beneficiary of that, which is really not a bad thing as it means the private market is insuring the lower down payments rather than the government."
The stocks of mortgage insurers like MGIC and Radian spiked in the first months of this year, as home prices improved and FHA policy changes designed to shrink its share of the market were announced. There is currently a bipartisan effort in the U.S. Senate to reduce the FHA's role, and in the House of Representatives a hearing is being held Wednesday looking at, "the competitive advantages the Federal Housing Administration has relative to private mortgage insurers and how those advantages contribute to the crowding out of private capital in housing finance," according to the House Financial Services Committee release.
Despite the advantages, FHA's share is already shrinking, as Fannie Mae's is rising. In the first quarter of 2012, loans with between 3 and 10 percent down payment made up 15 percent of Fannie Mae's business for home purchase loans (not refinances). In the second quarter it rose to 17 percent and in the third to 18 percent. Fannie Mae has not reported its fourth quarter yet, but that share is expected to rise again. While a credit thaw is part of it, as mortgage interest rates rise and fewer borrowers apply to refinance, lenders are simply looking for more business.
The banks are also catching their collective breath now after years of raging refinances. Record-low mortgage rates had borrowers refinancing over and over, and that left little capacity or need for the banks to take on more work in the form of home purchase loans.
With rates now rising to the highest level in six months, according to a report from the Mortgage Bankers Association Wednesday, the banks are seeing fewer refinances.
"Lenders, as traditionally happens, as they have more capacity, they might be willing to stretch their credit limits more," said Forlines.
Lenders may also be responding to clearer guidelines from Fannie Mae on how it will determine which defaulted loans it can force the banks to buy back. Banks had to buy back billions of dollars worth of bad loans during the housing crash due to failures in so-called "reps and warrants" (representations and warranties) on loans it sold to Fannie Mae.
They are also just responding to more business, particularly from first time home buyers who have been largely on the sidelines until now. Improving employment and more confidence in home prices are bringing these buyers back. Since first-time buyers tend to be younger, they may not have large down payments.
"More first time buyers are coming into the market now and we have seen this more in our pre-approvals in terms of comparing FHA vs. PMI," noted Strent. "Conventional options with PMI will become even more attractive when FHA premiums increase on April 1."
One wild card, however, is looming mortgage rules from Federal regulators that could require a minimum down payment for a loan to be considered a "qualified mortgage." Only these loans could be sold in full to investors; otherwise lenders would have to hold some portion of the loans on their books. Given new rules recently announced by the Consumer Financial Protection Bureau, industry organizations are lobbying heavily against that minimum down payment.
The idea behind the new mortgage regulations are to get lenders to have more skin in the game in order to prevent the reckless lending that brought on the housing crash. This as borrowers are apparently needing less skin in the game now to buy a home.