2018 vs. 2008: Better Equipped for the Next Mortgage Market Downturn
The mortgage market has shifted dramatically since 2008. Improvements in underwriting, technology, and quality controls – some visible, some less so – have resulted in a fundamentally sounder mortgage system than before the crisis of 2008. Lenders have strengthened their mortgage origination processes, including improved underwriting and collateral assessment. Additionally, appropriate regulations, such as the ability-to-repay and qualified mortgage rules, have formed guardrails for mortgage lending standards that did not exist 10 years ago.
Better Products, Better Credit
The mortgage system today is safer and sounder due to changes in credit eligibility standards following the crisis. Fannie Mae, one of the primary providers of market liquidity for mortgages, no longer purchases newly originated low- or no-credit documentation, negatively amortizing, or interest-only single-family loans, nor single-family loans with prepayment penalties or balloon payment features. These standards help to foster sustainable homeownership while continuing to provide opportunities for creditworthy borrowers to obtain financing and become homeowners.
Key measures of creditworthiness of Fannie Mae-purchased loans today are significantly stronger than they were in the period leading up to the crisis, from 2004 to 2007. FICO is a measure of credit history, which is the strongest predictor of mortgage delinquency. The average FICO credit score of borrowers with mortgages delivered to Fannie Mae in the second quarter of 2018 was 743. The average FICO credit score of our 2004 to 2007 acquisitions was 717. While FICO comparisons between the two periods can be difficult due to underlying changes in FICO in the last decade, it is clear that the general creditworthiness of today's borrowers is better than that of 2004-2007. Further, as of June 30, 2018, 91 percent of Fannie Mae's single-family conventional guaranty book of business consisted of loans that were originated after the 2008 crisis.
In 2018, some market observers have noted the recent increase in loan-to-value ratios for new mortgages. This shift is related to the changing demand for mortgage loans back to an understandable (and predictable) cycle. Today, the majority of consumers are obtaining loans to purchase a home rather than loans for refinance. "Purchase mortgages" typically have higher loan balances relative to a home's value (what we call a loan-to-value ratio) than refinance loans. Purchase loans made up 65 percent of the mortgages acquired by Fannie Mae in the second quarter of 2018. The last time that percentage was similar was in 2000, more than 17 years ago.
In 2018, the mortgage underwriting process itself has evolved into a fundamentally healthier one for both borrowers and lenders. Today, mortgage lenders have powerful new tools available to help them understand and assess credit and collateral risk. The amount and quality of data in each loan application and appraisal is better than ever before, and cutting-edge analytics help lenders identify and understand potential issues with a loan before it is closed – not after.
For instance, Fannie Mae's Desktop Underwriter® (DU®) risk assessment system is highly predictive of performance. Recent innovations such as the Day 1 Certainty® electronic data validation tools use verified source data to mitigate manual errors and potential fraud. The Day 1 Certainty enhancements enable lenders to access and immediately incorporate a borrowe's verified asset, income, and/or employment data into DU’s comprehensive risk assessment.
Another example is appraisal risk assessment tools such as Fannie Mae's Collateral Underwriter® (CU®), which enables instant validation of appraisal quality and value to an extent unimaginable in 2008. CU has eliminated millions of arguments between appraisal reviewers and appraisers about whether or not the estimate of property value is adequately supported by the particular comparable sales chosen by the appraiser. Today, all appraisals are electronically submitted by the lender. When CU analyzes an appraisal, it instantly provides real-time feedback to the lender, and accepts the appraised value on the spot if the CU risk score meets our criteria. A majority of the appraisals supporting loans delivered to Fannie Mae in the first half of 2018 received this instant validation of the appraised value, driven by significant enhancements in data and increased analytics on appraisal quality.
This "data over documents" approach has improved the quality of the data lenders use to underwrite loans and evaluate the properties used as collateral. Those who remember the last crisis know how important this is, because poor (or fraudulent) borrower and property data was a key feature of the disaster.
Since 2010, newly originated purchase loans delivered to Fannie Mae are required to be fully documented, and lenders have incorporated DU and CU enhancements to strengthen their loan manufacturing process. Further, lenders have also been able to use key quality checks at an earlier point in the origination process. Strong quality control tools and processes are now used as a loan is originated. The result: Loan defects have plummeted, and the percentage of loans with identified defects delivered to Fannie Mae in 2017 was less than 0.5 percent.
More and higher-quality data has allowed the industry to expand loan eligibility responsibly. One example is the debt-to-income ratio, or DTI ratio. As the name suggests, this ratio is the result of dividing a borrower's total monthly obligations into the gross monthly income. DTI ratio is one of the factors considered in DU's comprehensive risk assessment. For many years prior to the crisis we accepted loans with DTI ratios up to 65 percent. In December 2009, we set a maximum DTI ratio for newly acquired single-family loans of 50 percent, with any DTI ratio higher than 45 percent requiring strong compensating factors. This limit did not apply to our refinance of loans we already owned pursuant to our Refi Plus and Home Affordable Refinance Programs, which helped homeowners recover from the crisis.
In July 2017, changes went into effect that allowed more borrowers with DTI ratios above 45 percent to qualify for a Fannie Mae-guaranteed loan, up to the maximum of 50 percent. One result: The number of higher-DTI ratio loans surged. The percentage of Fannie Mae’s non-Refi Plus single-family loan acquisitions with borrower DTI ratios greater than 45 percent was 24 percent in the first half of 2018, up from 7 percent in the first half of 2017.
In March of this year, reflective of our ability to dynamically manage credit risk, we fine-tuned the DU model to reduce the number of eligible loans with multiple risk layers, including those with DTI ratios greater than 45 percent. Risk layering refers to loans with multiple higher-risk characteristics such as high loan-to-value ratio, credit profile with a history of delinquencies, DTI ratio above 45 percent, and no or low levels of reserves. This is a prime example of how data is being used at the point of loan origination to make underwriting mortgages more accurate, certain, and transparent. This dynamic approach has benefited borrowers, lenders, and the system as a whole – and allows mortgage guarantors such as Fannie Mae to manage credit risk with greater agility.
In 2008, the mortgage and housing market experienced a disaster. In 2018, market players, including borrowers, are behaving in ways that are rational and in keeping with understandable cycles. In 2018, they also rely on more verified, accurate data than ever before. This trend will continue to gain steam, as will the tools available to analyze that data.
These changes can't by themselves prevent another downturn in the housing market, which by its nature is cyclical. But these changes have made the housing system far more resilient and better prepared for whenever the downturn comes.
Vice President, Single-Family Risk Management
September 21, 2018