A Continued Economic Recovery Depends on Access to Credit

A Continued Economic Recovery Depends on Access to Credit

Kurt Usowski, Deputy Assistant Secretary for Economic Affairs Six years after the end of the Great Recession, the economy is showing signs of a consistent recovery. Gross domestic product (GDP) grew at an annual rate of 5 percent in the third quarter of 2014, the strongest single quarter since 2003. Between 2013 and 2014, the unemployment rate had its sharpest decline since 1984, and total employment in 2014 rose by more than in any calendar year since 1999. The lackluster housing market, however, has impeded a more robust recovery; analysts estimate that GDP would have grown an additional 1.5 to 2 percent if residential investment were at normal levels. Although housing recoveries typically precede broader economic recoveries, the housing sector has lagged this time around, likely because the latest recession was driven by the collapse of the housing market. Despite rising home prices in many parts of the country, 9.8 million households are still underwater, representing 19.4 percent of all mortgaged homes, and purchase originations, which declined by 44 percent between 2001 and 2012, remained stubbornly low through 2013 and 2014.

Some suggest that the lagging housing market is a result of changing preferences and stagnant incomes. Clear evidence exists, however, that the limited availability and elevated costs of credit are major factors. Compared with more typical lending periods, median FICO scores for purchase loans have increased by nearly 50 points, to the 750s, and the composition of FICO scores has changed, with substantially reduced lending to mid- and lower-range FICO borrowers. Although 40 percent of borrowers from 2000 to 2003 had FICO scores below 680, this segment represented just 22 percent of borrowers in 2013 and 2014. As the Federal Reserve Bank of Boston notes, “Households with FICO credit scores below 620…[have] lost any access to mortgage borrowing.” By contrast, the percentage of borrowers with higher FICO scores has grown; 37 percent of borrowers in 2013 and 2014 had FICO scores above 760 compared with just 21 percent between 2001 and 2003. If the changing housing market were purely a result of changing tastes and incomes, then we would not have seen such radical changes in the distribution of FICO scores among mortgage borrowers.

Borrowers shut out of traditional financing sources typically turn to the Federal Housing Administration (FHA), the primary source of lending for first-time homebuyers and low-income borrowers. FHA requires a minimum credit score of 580 and a 3.5 percent down payment. Even a modest down payment, however, can be a major hurdle for first-time homebuyers. Since the crisis, fewer borrowers with lower FICO scores have been able to access FHA loans; lenders are applying their own minimum credit scores well above the FHA floor. In 2001, FHA borrowers had a median FICO score of approximately 640, but by 2013 and 2014 the median score had climbed to 690. The impact of this increase is significant because 13 million potential borrowers have FICO scores between 580 and 640.

Even when borrowers with lower FICO scores can access credit, they face higher costs. In the conventional market, the introduction of risk-based pricing has driven up rates for less creditworthy borrowers. A borrower with a FICO score of 630 pays interest rates that are up to 1.5 percent higher, or $3,000 more per year, than a borrowers with a 760 FICO score, on a $200,000 mortgage. FHA also more than doubled its mortgage insurance premium (MIP) between 2008 and 2014 to rebuild the Mutual Mortgage Insurance Fund.

The result of credit rationing and higher rates has been a decline in first-time homebuyers, whose numbers have dwindled in recent years from 40 percent of all homebuyers to just 28 percent. This decline is not attributable to a change in the desire for homeownership. Despite a rising proportion of renters and a growing trend to delay household formation, homeownership remains popular, with most renters planning to eventually become homeowners. Their problem, however, is access to credit and cost.

This decreased access to credit for first-time buyers and other lower-credit borrowers is significant because housing is a primary source of wealth accumulation for median- and low-income families. Homeownership is also a traditional gateway to the middle class and is associated with more stable communities and better school districts.

To ensure that Americans who want to become homeowners can do so, the Obama administration has been working on several policy responses to promote credit access for qualified borrowers.

As an immediate response to the foreclosures that triggered the recession, the administration launched mortgage modification initiatives to prevent foreclosure and maintain homeownership. Collectively, the Making Home Affordable programs have assisted more than 8 million homeowners.

In response to tight borrowing conditions for its traditional market, FHA launched its Blueprint for Access in May 2013. This initiative includes programs to reduce lender uncertainty and facilitate lending to the full spectrum of FHA-eligible borrowers. For example, FHA will publish clearer guidelines and improve the way it measures lender performance.

In addition, in fall 2014 the Federal Housing Finance Agency (FHFA) renewed efforts to clarify lending rules for the government-sponsored enterprises to reduce credit overlays in the conventional market. FHFA also announced that Freddie Mac and Fannie Mae would renew purchases of certain low-down-payment mortgages, providing liquidity for less affluent but creditworthy borrowers.

More recently, in January 2015 FHA announced that it would reduce annual MIP rates from 1.35 percent to 0.85 percent, saving new borrowers an average of $900 per year. These lower rates will benefit 800,000 borrowers annually, and reduced premiums will allow 250,000 new homebuyers to purchase homes over the next 3 years. These steps will support home sales, reduce housing expenses for new homebuyers, and help balance the housing market. As it has always been with fully compliant FHA-insured loans, credit will be extended only to borrowers who can make consistent payments on a well-underwritten and fully documented mortgage.

Moreover, efforts to improve access to credit are also important for renters. First-time homebuyers traditionally are former renters, thus reducing the demand for rental housing. Even so, more needs to be done to support rental affordability.

Six years after the end of the Great Recession, housing is improving. Removing unnecessary costs and reducing credit rationing will further the broader economic recovery and benefit low- and moderate-income Americans.