Loosening of Lending Standards Harms Low Income and Minority Americans

The Spring home buying season continues to show strength, buoyed by strong first-time buyer volume and share. Historically low mortgage rates, an improving labor market, and loose credit standards, combined with a 32-month-long seller’s market for existing homes, continue to drive up home prices faster than income.

The continued loosening of lending standards during a strong seller’s market is moving the goalpost further away for many lower income and minority renters desiring to become homeowners.

• In June* first-time buyers accounted for 58.8 percent of primary owner-occupied home purchase mortgages with a government guarantee, up from 57.2 percent the prior June.
• Increasing first-time buyer volume and share is being driven by increasing leverage and a strengthening job market.
• The number of primary owner-occupied purchase mortgages going to first-time buyers in June totaled an estimated 128,000, up 20 percent from the 107,000 mortgages in June 2014
• The Agency FBMRI stood at a series record of 15.83 percent, up 0.5 percentage point from the average over the prior three months and up 1.1 percentage points from a year earlier.
• The Agency FBMRI is 6¾ percentage points higher than the mortgage risk index for repeat home-buyers, and the gap has been widening.
• Nearly 55 percent of agency first-time buyer loans were high risk (an MRI above 12%) in June, up from 51 percent a year earlier.
• As demonstrated below, the extremely small sample size of the NAR’s realtor survey generates monthly noise that tends to mask both seasonal and underlying trends in first-time buyer share, trends readily apparent in the AEI combined first-time buyer share index.

The First-Time Buyer Mortgage Share and Mortgage Risk Indexes (FBMSI and FBMRI) are key housing market indicators based on monthly data for nearly all government-guaranteed home purchase loans, which greatly reduces the risk of sample error. By relying on millions of loans, this approach stands in contrast to traditional first-time buyer surveys based on small samples of home-buyers or real estate agents.

In June 2015, first-time buyers accounted for 58.8 percent of primary owner-occupied home purchase mortgages with a government guarantee, according to the Agency First-Time Buyer Mortgage Share Index (FBMSI).  As shown in the chart below, the June share was 0.2 percentage point above the revised share of 58.6 percent for May and 1.6 percentage points above the June 2014 share of 57.2 percent.  Through March of this year, the first-time buyer share had displayed no clear trend apart from seasonal variation. But the increases in April, May, and June pushed the share to successive new highs, supported by improvements in the labor market, riskier mortgage lending, and continuing low mortgage rates.  These factors, combined with a 33-month-long seller’s market for existing homes as reported by the National Association of Realtors (NAR)[1], are driving up home prices faster than income.

“The housing lobby, led by the NAR and the Urban Institute, has successfully pushed for looser lending standards for first-time buyers,” noted Edward Pinto, co-director of the American Enterprise Institute’s (AEI’s) International Center on Housing Risk. “Rather than increasing accessibility, the loosening of lending standards during a strong seller’s market is moving the goalpost further away for many lower income and minority renters desiring to become homeowners.”

The chart below displays the monthly first-time home-buyer percentage by agency.  As shown, the share varies widely across agencies.  FHA is at the high end with a share at or above 80 percent, while Freddie Mac is at the low end with a share of about 40 percent.  Fannie Mae’s share has consistently tracked somewhat above Freddie’s and stood at 46.7 percent in June. Fannie’s share is higher because of its much greater volume of 97 percent LTV loans for first-time buyers relative to Freddie.  These loans carry substantial risk and account for most of the gap between Fannie’s MRI for first-time buyers (8.18 percent in June) and Freddie’s (6.72 percent).

As shown by the blue line in the chart below, the Combined FBMSI (which measures the share of first-time buyers for both government-guaranteed and private-sector mortgages) stood at an estimated 52.9 percent in June 2015.  Consistent with the agency series, the broader combined share moved to successive highs in April, May, and June, after having varied seasonally with no trend over the prior two years.  The first-time buyer share published monthly by the NAR, the dotted red line, also has risen to the highest level over the period shown.  Although the two series are currently sending the same message, the NAR series provides a much noisier signal month to month because of its small sample size.[2]

The first-time buyer share shown by the combined FBMSI is much higher than that estimated by the NAR survey of realtors and the separate NAR survey of homebuyers and sellers.  This gap largely appears to reflect a difference in the definition of first-time buyers.  In the federal agency data that we use, first-time buyers include purchasers who owned a home more than three years ago but not in the past three years.  The NAR surveys ask whether the purchaser is a first-time buyer, without further instruction.  Survey respondents likely apply a literal definition of first-time buyers, which would exclude purchasers who owned a home more than three years ago.[3]  The broader definition in the federal agency data captures the full set of households transitioning from renter to homeowner status and thus provides a more complete measure of changes in demand for owner-occupied housing.  The rising first-time buyer share and the strong increase in first-time buyer sales volume shown by our broad definition help explain the tightening inventory conditions in the long running seller’s market.  The unsold inventory of existing single-family homes stood at 5.2 months in May, down from 5.6 months a year earlier; for new single-family homes, the unsold inventory was 4.5 months in May, down from 5.1 months a year earlier.[4]

The monthly count of agency first-time buyer mortgages (theAgency FTB Loan Count) is presented in the chart below.  The number of primary owner-occupied purchase mortgages going to first-time buyers in June totaled an estimated 128,000, up 20 percent from the level in June 2014.  This increase in the Agency FTB Loan Count outpaced the 15½ percent rise in total agency purchase loan volume over the same period.

The Agency FTB Loan Count and the Agency FBMSI are calculated, as noted above, from a nearly complete dataset of government-guaranteed home purchase loans, which greatly reduces the risk of sample error. Data on the importance of first-time homebuyers for non-agency loans are not available to our knowledge from any source.  The Combined FBMSI is calculated from the agency loan data, along with assumptions for non-agency loans that we believe to be reasonable.

“While the strength of this Spring’s homebuying season is noteworthy, it is being unsustainably fueled by increasing leverage,” said Pinto. “This leaves first-time buyers and neighborhoods vulnerable to excessive defaults.”

“We paint an accurate picture of changes in the first-time buyer share by using a nearly complete census of agency loans,” said Stephen Oliner, co-director of AEI’s International Center on Housing Risk.  “In contrast, the monthly changes in the first-time buyer share from the NAR survey are often just noise.”

AEI’s Agency First-Time Buyer Mortgage Risk Index (FBMRI) estimates the share of first-time buyer mortgages that would default in a stress event comparable to the 2007-08 financial crisis based on the actual performance of loans originated in 2007.  The Agency FBMRI stood at 15.83 percent in June, up 0.5 percentage point from the average over the prior three months and up 1.1 percentage points from a year earlier. As indicated in the chart below, the Agency FBMRI is 6¾ percentage points higher than the mortgage risk index for repeat home-buyers, and the gap between the two series has been growing.

The higher risk for the mortgages taken out by first-time buyers is largely due to risk layering. As shown in the table below, in June 2015, 71 percent of first-time buyer mortgages had a combined loan-to-value ratio (CLTV) of 95 percent or higher, and 97 percent had a 30-year term. Given the combination of little money down and slow amortization, these buyers will have very little home equity for a number of years unless their house appreciates substantially. In addition, more than one-fifth of first-time buyers taking out mortgages had a FICO score below 660, the traditional definition of subprime mortgages, and one-quarter had total debt-to-income ratios above 43 percent, the limit set by the Qualified Mortgage rule.  The mortgages taken out by repeat buyers are less risky along two dimensions in particular: a much smaller share had a CLTV of 95 percent or higher and a smaller share had a FICO score below 660.

Characteristics of Mortgages Taken Out by First-Time and Repeat Home-buyers:

This risk profile for first-time buyers implies that the supply of mortgage credit to this group is not tight.  In June 2015, the median first-time buyer with an agency mortgage made a downpayment of only 3 percent, or $6900 in dollar terms.  Moreover, the median FICO score in June for first-time buyers with agency mortgages was 706, slightly below the median of 713 for all individuals in the United States with a score.[5] For first-time buyers with FHA-insured loans, the median FICO score in June was only 674, well below the middle of the distribution for the U.S. as a whole. These data are a strong counterpoint to the frequent claims that first-time buyers face difficulties in obtaining mortgages.

“Our data refute the conventional wisdom that first-time buyers face tight credit,” said Oliner.  “Many first-time buyers with ordinary credit scores are purchasing homes every month with little money down.”

ABOUT THE FBMSI AND FBMRI

The FBMSI and FBMRI are objective and transparent measures of the first-time buyer share and the riskiness of first-time buyer mortgages, respectively, based on the millions of loans contained in the National Mortgage Risk Index (NMRI) database developed by AEI’s International Center on Housing Risk. The FBMSI, FBMRI, and NMRI are updated monthly.  For more information about these indexes and the work of the center, please visit HousingRisk.org or contact Edward.Pinto@AEI.org or Stephen.Oliner@AEI.org.

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