prices, combined with a low-inflation economy, means that homes are
steadily getting more expensive compared with other goods and services
that households can buy. Moreover, gains in home prices are
outstripping wage gains. That creates a gold-rush mentality in which
potential homebuyers rush to grab a house as quickly as possible, even
if they overpay.
And mortgage lenders are willing to oblige, even in the case of buyers
who might not have qualified before. The average downpayment has
dropped to only 5% to 10% over the past decade rather than the 10% to
20% it was in the past, according to Doug Perry, a first vice-president
at mortgage lender Countrywide Home Loans Inc. Under the right
conditions, Countrywide is even willing to lend homebuyers 103% of the
value of their new home to cover their closing costs, too.
In part, the aggressive tactics of mortgage lenders have been made
possible by the automated underwriting systems developed in recent
years by the Federal National Mortgage Association (Fannie Mae) and the
Federal Home Loan Mortgage Corporation (Freddie Mac). These two
government-created companies buy 70% of new mortgages in the U.S. and
repackage them as mortgage-backed securities, which they then sell to
The new underwriting systems being used by Fannie Mae and Freddie Mac,
which are analogous to the credit-scoring systems used by banks, allow
for higher loan-to-income ratios than in the past to encourage home
buying. That’s good for borrowers, but the relaxed ratios could pose
serious problems in the future. For one, there is already evidence that
defaults are rising, particularly at the low end of the market, where
there is a concentration of homeowners who might not have owned houses
without the mortgage boom. The Federal Housing Administration (FHA),
which makes low-income loans, saw mortgage delinquencies and
foreclosures jump to 0.71% of its portfolio in the middle of last year.
"That number has been hanging around 0.59% for years," says Wharton’s
Wachter, who used to work at the Office of Housing & Urban
Development (HUD), which collects these statistics. That may not sound
like much of a jump, but it amounts to about a $600 million increase in
For Fannie Mae (FNM
) and Freddie Mac (FRE
), which only began expanding into subprime mortgages two years ago,
deteriorating credit quality may be a new and unpleasant experience.
Since they control such a big chunk of the market, if their portfolios
are perceived to be more vulnerable to credit issues, that could boost
mortgage rates across the country.