Interest Rate Roundup

Wednesday, February 14, 2007

The implications of tighter mortgage lending standards

It seems every day, another mortgage lender pulls one of its higher risk products. In the Wall Street Journal this morning, there's a story titled "Home Lenders Pare Risky Loans
More Defaults Prompt Cut In 'Piggyback' Mortgages;Housing Market May Suffer." You'll need a subscription to read the whole piece, available here. But here's an excerpt:

"Fremont General Corp., a major lender to people with weak credit records, has stopped providing these second mortgages, which are frequently used by financially stretched "subprime" borrowers who can't scrape together a down payment. A spokeswoman for Fremont, based in Santa Monica, Calif., confirmed the decision, which was first announced in emails to mortgage brokers earlier this week, but she declined to comment further.

"Fremont's move comes amid a rapid tightening of credit standards by subprime lenders as they find investors no longer are eager to buy types of loans deemed particularly prone to default. The pullback by subprime lenders could put a further dent in demand for housing by preventing some potential buyers from getting loans at a reasonable cost."

As I've been pointing out in earlier blog posts, including this one on the Fed's latest loan officer survey, the thing that had been missing in this housing market slump -- until recently -- was a tightening lending market. Lenders kept the pedal to the metal DESPITE obvious signs the housing market was deteriorating in 2005-2006. Their goal: Keep loan volume up, future defaults be damned.

Now, that's changing fast as secondary market conditions tighten up. Will this have a "second round" impact on the housing market? I believe so. More borrowers at the margin will not qualify for financing, and that will erode demand for both new and existing homes. My advice if you're gearing up for the spring real estate season:

* If you're a home buyer, you should recognize that tighter mortgage standards reduce your buying power. For example, you may have to come up with a larger down payment to qualify for a loan. That’s especially true if you have a lower credit score. Stated income financing and some higher-risk ARMs may also be tougher to find or more expensive.

*If you're a home seller, you should be more flexible on pricing. You're already competing with a near-record number of new and existing homes on the market. Now, you have to consider the possibility that prospective buyers will ultimately fail to obtain mortgage financing.


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