It's time to expand the credit box for American homebuyers
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The dark, dark days of the mortgage market are far behind us. The early 2000s were marked by a set of practices that can only be described as abusive. Consumers saw teaser interest rates that morphed into unaffordable rates soon thereafter, high fees that were foisted upon borrowers at the closing table and loans packed with unnecessary and costly products like credit insurance.

After the financial crisis hit, Congress enacted the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. The law included provisions intended to protect both borrowers and lenders from the craziness of the previous decade, when no one was sufficiently focused on whether loans would be repaid or not.

The Consumer Financial Protection Bureau (CFPB) promulgated the rules that Dodd-Frank had called for, like the ability-to-repay and qualified mortgages rules. These rules achieved their desired effect as predatory mortgage loans all but disappeared from the market.

But there were consequences, and they were not wholly unexpected. Mortgage credit became tighter than necessary. People who could reliably make their mortgage payments were not able to get a mortgage in the first place. Perhaps their income was unreliable, but they had a good cushion of savings. Perhaps they had more debts than the rules thought advisable, but were otherwise frugal enough to handle a mortgage.

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These people banged into the reasonable limitations of Dodd-Frank and could not get one of the plain vanilla mortgages that it promoted. But many of those borrowers found out that they could not go elsewhere because lenders avoided making mortgages that were not favored by Dodd-Frank’s rules.

Commentators were of two minds when these rules were promulgated. Some believed that an alternative market for mortgages, so-called non-qualified mortgages, would sprout up beside the plain vanilla market, for good or for ill. Others believed that lenders would avoid that alternative market like the plague, again for good or for ill. Now it looks like the second view is mostly correct and it is mostly for ill.

The Urban Institute Housing Finance Policy Center’s latest credit availability index shows that mortgage availability remains weak. The center concludes that even if underwriting loosened and current default risk doubled, it would remain manageable given past experience.

The CFPB can take steps to increase the credit box from its current size. The “functional credit box” refers to the universe of loans that are available to borrowers. The credit box can be broadened from today’s functional credit box if mortgage market players choose to thoughtfully loosen underwriting standards, or if other structural changes are made within the industry.

The CFPB in particular can take steps to encourage greater non-qualified mortgage lending without needing to amend the ability-to-repay and qualified mortgages rules. CFPB Director Richard Cordray stated earlier this year that “not a single case has been brought against a mortgage lender for making a non-[qualified mortgage] loan.”

But lenders have entered the non-qualified mortgage market very tentatively and apparently need more guidance about how the Dodd-Frank rules will be enforced. Moreover, some commentators have noted that the rules also contain ambiguities that make it difficult for lenders to chart a path to a vibrant non-qualified mortgage line of business. Lenders are being very risk-averse here, but that is pretty reasonable given that some violations of these rules can result in criminal penalties, including jail time.

The mortgage market of the early 2000s provided mortgage credit to too many people who could not make their monthly payments on the terms offered. The pendulum has now swung. Today’s market offers very few unsustainable mortgages, but it fails to provide credit to some who could afford them. That means that the credit box is not at its socially optimal size.

The CFPB should make it a priority to review the regulatory regime for non-qualified mortgages in order to ensure that the functional credit box is expanded to more closely approximate the universe of borrowers who can pay their mortgage payments month in, month out. That would be good for those individual borrowers kept out of the housing market. It would also be good for society as a whole, as the financial activity of those borrowers has a multiplier effect throughout the economy.

David Reiss is a professor at Brooklyn Law School and director of academic programs at the Center for Urban Business Entrepreneurship. He is the editor of REFinBlog.com, which tracks developments in the changing world of residential real estate finance.


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