A plan to jump-start housing
A plan to jump-start housing
Editor's note: This is the second in a three-part series.
The first article in this series argued that a rollback of Fannie Mae and Freddie Mac lending terms to where they were before the financial crisis was needed to prevent a second round of home-price declines.
In addition to benefiting homeowners and the economy, this would reduce Fannie-Freddie losses on both old and new loans, which makes it a requirement of responsible conservatorship.
This article and the one that follows will discuss a few of the many specific changes in underwriting rules that are needed.
Modify rigid affordability rules
The post-crisis rule that every mortgage loan must be affordable to the borrower was a knee-jerk reaction to the excesses of the bubble period, when many adjustable-rate loans to subprime borrowers were not affordable past the initial rate period -- usually two years.
The blanket affordability requirement that emerged is preventing loans from being made that are safe to the lender and useful to a borrower who can't meet affordability tests.
Mortgage loans are distinguished from all other loans by their collateral, and for a long period in our history, lenders based their decisions only on the collateral value. Incorporating credit and income affordability into the decision process was an advance, but making affordability an absolute requirement was a step backwards.
In some situations, unaffordable loans are in the interest of borrowers facing temporary problems. If the property value is sufficient, there is every reason such loans should be made.
Eliminate income documentation requirements for sterling borrowers
The rule-restricting frenzy that produced the blanket affordability requirement also created the full-documentation rule. This abruptly terminated an industry trend toward increasing flexibility in documentation requirements.
As an example, before the crisis a borrower who could not document income but was top drawer in all other respects would have been approved under one or another alternative documentation rules.
The sensible presumption was that such a borrower knew more about what he could afford than the underwriter, and in the unlikely case where the presumption was wrong, the lender was protected by the property.
Today, such borrowers are being rejected out of hand. Because alternative documentation provisions were grossly abused during the bubble period preceding the crisis, all of them were eliminated in the mindless frenzy of rule tightening. The blanket rule today is full documentation of income for at least two years.
If the cardinal sin of the bubble period was providing credit to the hopelessly unqualified, the cardinal sin today is denying credit to the exceptionally well-qualified -- many of whom are independent contractors. They are the "disadvantaged group" of the post-crisis era, and their numbers are growing rapidly.
A useful if partial step toward sensible documentation rules is simply to eliminate the income documentation requirement for otherwise sterling borrowers. Such a borrower might be defined as one with a credit score of 740 or higher, down payment of 20 percent or more, and payment reserves of six months or more.
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