Those Wacky Politicians
Why Pay Rent?
In previous posts, we covered an early bill introduced in Congress to provide grants, not tax credits, to certain individuals to use towards a down payment. Joe Biden had proposed a tax credit, but the plan morphed a bit. Now those wacky politicians plan to top themselves! It’s common for government programs to try to pick winners and losers. People support that as long as they fall on the winners side.
During the week of August 9, the Federal Housing Finance Agency (FHFA) demonstrated once again that feel-good government interference may lead to a 2008 type crisis. Reward bad behavior and you get more of it. Fannie Mae now will take on-time rent payments into account during its underwriting process. Fair enough. A good payment history should accurately help a borrower qualify. Fannie Mae estimates about 20% of consumers don’t have an established credit history. This won’t be the item which leads to a crisis.
But the red flag warnings are increasing as noted below. Borrowers refinancing and taking out loans bigger than what they originally owed (cash-out refinancing) now is highest in 15 years.
Illogical Flip Side
Conversely, Fannie Mae will not take into account delinquent and missed rent payments as a negative indicator. A Moody’s analysis estimated the average past-due renter was $5,600 behind on rent. So, a renter who cannot make rent payments on time becomes a good risk that, as a borrower, mortgage payments in an amount greater than rent rates will be paid on time? A renter could have been skipping rent payments for much of the last 18 months to save toward a federally backed mortgage. This sounds like encouragement to skip payments to landlords who, quite understandably, should be enraged by rewarding bad behavior. What other bad behavior will FHFA and Fannie Mae reward next to get us to the new crisis?
What do statistics show about missed payments as a predictor of default? A Fannie Mae study showed that regardless of credit score, borrowers who missed one payment were significantly more likely to default, going 60 days past due. Those with a credit score under 700 went 60 days past due 7 to 8 times more often than those missing no payments. For credit scores above 700 the borrowers went 60 days past due by 16-25 times more often! So why omit negative performance?? Politics. If enacted, defaults will likely soar in the 2023-24 time frame and continue at elevated levels with borrowers clamoring for more government help. FHFA, CFPB, HUD, and courts will acquiesce, extend forbearance, delay foreclosures, and punish servicers and lenders.
Subprime Resurrection
On August 18, FHFA announced a proposal to increase the loans made by Fannie and Freddie to low income borrowers. In a replay of the pre-2008 decision making, politics trumps responsibility. The comment period for the proposed rule runs for 60 days. Any bets if the comments received by FHFA make any difference to the final decision and rule? They won’t make any difference. What changes in the new proposed rule? The current benchmark level (2018-2021) for single family housing goals has a low-income home purchase goal of 24% of mortgages to low income buyers. Under the proposed benchmark level, that would increase to 28%. The very low-income home purchase goal, currently at 6%, would increase to 7% between 2022 and 2024.
Pre-2008, reports surfaced that Fannie and Freddie had built up ownership of subprime mortgage to become the bulk of their respective portfolios. The new purchase goal of only 35% of mortgages leads to perhaps a larger owned percentage later. If they don’t default, these subprime loans may stay on the books while other mortgages get paid off. By staying on the books, think years of delinquencies, workouts and political rules like 2008. Helping lower income earners seems a logical and benevolent goal. But putting individuals struggling to meet rent payments into housing which will require an even greater share of income to pay for actually hurts these families.
2008 Subprime Debacle
The exact goal of putting lower income borrowers into homes led to the 2008 debacle engineered by politicians, Fannie and Freddie. It also led to fraud and abuse. And, the push of borrowers into homes they could not afford flamed out spectacularly as the prime cause of 2008.
At that time, Fannie Mae and Freddie Mac were bloated with extremely high paid ex-Clinton administration bigwigs drawing salaries and bonuses into the 10s of millions. They pumped up Fannie Mae and Freddie Mac loan volumes and reported “profits.” When the “profits” proved illusory and ephemeral, how many returned the big salaries and bonuses? That’s right, none. How many took any responsibility for the debacle? That’s right, none. Another notch in the 2008 replay may be put in place shortly!
In a recent article by the former head of the Federal Home Loan Bank of Chicago, the federal government already may be teeing up the next housing bust.
Down Payment Assistance Bill
In summary, the early bill would provide up to $25,000 towards down payment for a special class of buyer. No, probably not you. The money would have multiple layers, so smaller numbers of buyers would qualify for the maximum. Some of the tests proposed to qualify include:
- First generation home buyer (unless parents previously owned a home which was foreclosed)
- Economically disadvantaged (race based)
- Means-tested, based on income and area housing prices
- Funds allocated to states based on population, home prices and racial composition (race based)
State finance agencies would be tasked with administering the program and distributing the funds. But they could delegate that responsibility to community-based nonprofit entities. [Historically, this group makes up the greatest fraud, vote buying, and politically connected entities].
The impact a down payment assistance program would have on the housing market can’t be overstated. The free money would encourage more bidding for homes across the low to moderate price spectrum. Already in short supply, these home would face increased prices. The likely outcome would be greater price increases. Winning Mortgage, Winning Home discusses in depth the eerily similar Nehemiah programs prior to 2008. Those substantially contributed to the 2008 meltdown. If you haven’t read this, you should.
First Responder and Teacher Subsidy Bill
On May 13, a bill introduced in committee in the US Congress would target first responders and teachers. Named the “Homes for Every Local Protector Educator and Responder Act,” the bill seeks to allow borrowers to finance up to 100%. The program would flow through FHA and would be subject to FHA loan limits. Home buyers would pay an up-front mortgage insurance premium of 3.6 percent of the principal. This MIP could be financed (rolled into the mortgage so a borrower would effectively borrow 103.6%). No monthly MIP would be required.
Greater than 100% loans were common pre-2008. In fact, many renters who could not qualify for renting an apartment were able to buy a home pre-2008 with up to 107% financing. Virtually none of those buyers avoided default and foreclosure. How were these individuals helped by buying something they in reality could not afford?
Who Qualifies
Police officers, prison guards, firefighters, paramedics, emergency medical technicians and public or private school teachers would all be eligible. Eligible borrowers must have worked in one of those professions for at least four years. They also must be in good standing at their job, and not subject to disciplinary action. They must also show that they intend to keep working in the same job for another year.
While noble in intent, the road to hell is paved with good intentions. Where have we seen this movie before where borrowing more than 100% is encouraged by our friends in the government just here to help? Correct, prior to 2008. What could possibly go wrong?
Caveats
Veterans loans also provide up to 100% financing. This program has existed for decades. An upfront PMI payment requirement kicks in along with monthly MIP payments for the loan. In the current market though, sellers treat loans with VA financing almost as being toxic. They are popular, but not with sellers. The additional steps and requirements to complete a VA loan take time and energy. In the end, the requirements also may tank a proposed transaction due to additional appraisal, inspection and other unique aspects of the program. Sellers, who now have many offers to choose from, are not likely to look favorably on anything that entails more complicated financing.
So adding the proposed financing in a manner similar to VA loans may not help those first responders and teachers in the present market. In fact, in the present market, the program likely will create the additional demand imbalance noted in the down payment assistance bill. Presumably, the administration by FHA (a guarantee) will also mean targeting lower credit scores like FHA credit and underwriting requirements.
End Results
The overall problem with many of these efforts isn’t the intentions behind them. Like the period running up to 2008, the programs put individuals into homes they truly cannot afford. This sets up failure for the buyers. It also won’t get more homes built in areas such as California which specifically make it extremely difficult and expensive to build a new home. Due to California’s property tax structure, new home builders can pay more just in permitting costs than the total cost of homes in other parts of the country.
It is much easier for politicians to throw money at the demand side of the economy than to look at themselves and the havoc they have created on the supply side. Throwing money makes politicians feel good about themselves rather than truly examine the cause and effect of their actions. To paraphrase Barbara Timmerer (a congressional staffer) from RTC problems 30 years ago -“We passed the bill and solved the problem. And if you don’t believe me and do what we want, we’ll pass another bill.” In essence, solving the problem in Congress isn’t the actual goal — perverse rules and incentives breed perverse results. Government intervention has become an end unto itself. But politicians can brag at election time, no matter the actual results from their efforts.
Current Risks versus 2008
Let’s look at the proposed programs today and the checklist of causes of 2008.
- Gifted down payments — Check (Nehemiah)
- Greater than 100% financing — Check
- Targeting highest risk borrowers — Check
- Government intervention encouraging risk — Check
- Effectively relaxed credit standards — Check
- Cash out refinancing (refinancing and borrowing more than originally owed) in 2021 reaches highest level since 2007
- We don’t have Option ARMs yet, but rates pushed to rock bottom levels as manipulated by the Federal Reserve (aka US government). Option ARMs played that role pre-2008. The lower monthly payments enabled buying a home which otherwise financial ability didn’t allow. Option ARMs provided a bet on quickly rising home prices. – Not yet…
- In 2020, the use of “blind” appraisal waivers by lenders reached staggering, record highs. Many had no inspection or appraisal of any kind performed on the property. During peak months, 70–80% of all rate-and-term refinancing transactions lacked an appraisal. So, perhaps loaning with no real equity (see Nehemiah also) — Check!
Additional Risks
In the present market though, we also get the benefit of mandated forbearance. No payments even! CFPB has proposed no foreclosures until the end of 2022. No payments, no down payment, no appraisal, no inspection, more than 100% financing, lower credit, no risk of foreclosure. What could possibly go wrong? Fortunately, the appraisal waiver allowance goes away. Verification requirements remain strict. Very few no income, no asset loans in the pipeline. But some buyers still waive inspections.
Keep an eye on these bills. If actually passed, we will re-examine our Advantageous Buying Window forecast. It may actually switch to an Advantageous Selling Forecast if the demand imbalance accelerates as may be likely. You may be the biggest beneficiary in selling if your home would require a mortgage of less than $548,000 and fit into the new programs.
Homeowners in the U.S. withdrew $63 billion in equity from their homes across more than 1.1 million cash-out refinances in the second quarter, the largest quarterly volume since mid-2007, according to Black Knight.
Comparison to 2009 First Time Buyer Credit
Many advocates of the first time buyer credit point to the 2009 first time buyer credit to justify the current proposals. However, in 2009, two major problems ruled the day. First, a lack of lending froze much of the market. Second, available homes vastly exceeded the demand. In 2021, lending is plentiful. In addition, a shortage of homes exists. The shortage affects first time, lower priced homes more than other sectors. So, adding demand for homes which are in short supply will cause prices to skyrocket.
Simple supply and demand. Demand by those with free money will eclipse demand by those using their own money. And they will likely buy houses for which the price was bid higher, resulting in little or no equity despite free money. Affordability also becomes an issue going forward for the overpriced home. Repeating the pre-2008 mistakes instead of the 2009 program will lead to greater risk for buyers and the market in general