The Federal housing administration over the last several years has been quietly easing the lending standards to increase home ownership. Montgomery, the director of the FHA, did an abrupt change this month tightening standards “to maintain a better balance of managing risk and fulfilling its mission”. What was the change? Why is this important now? Is FHA the only one pulling back? Why are banks jumping on the bandwagon?
What changed?
The FHA since 2016 has been loosening its underwriting standards on both credit scores and debt to income ratios. Starting 3/18/19 these standards will change putting many more files into manual underwriting flagging them as high risk. This will impact 40-50k loans a year meaning about 4-5% of loans will now be subject to increased underwriting.
The reason for the change now is I suspect someone was looking at the FHA portfolio and had an Oh sh** moment when they realized the outsized portion of the portfolio that is at much greater risk of default due to very low down payments and higher debt to income ratios. This led to the abrupt change in underwriting to try to mitigate future risk as the economy enters a new cycle. Unfortunately, the changes now might be too late as the real estate market is already starting to cool.
What is the impact?
With increased underwriting of “higher risk” loans, less loans will be approved by FHA due to credit, income ratios, or down payment amounts. Many of the “high risk” loans will be denied due to additional underwriting. This will eliminate many first-time homebuyers ability to purchase a home as the FHA is the largest provider of low down payment loans in the country.
Banks also pulling back.
Along with the FHA, banks are also pulling back. A federal reserve bank survey in October of 2018 found banks will also start pulling back if the yield curve were to invert
Banks told the Fed that they would tighten lending standards if short-term rates rise above their long-term counterparts, the central bank said Tuesday in results of an October survey of senior loan officers. Asked how an inversion of the yield curve would impact lending practices, a “major share” of banks in the survey said they’d become less profitable and more risk-averse.
Banks saying an inversion would cause them to tighten lending standards would be “like a piling-on effect in terms of a slowdown, as tighter lending standards tend to reinforce any slowdown,” Herrmann said.
The yield curve just inverted in March meaning that short term rates exceeded long term rates. Banks have already started pulling back the reigns on lending by focusing on only the highest quality transactions that will be able to weather an economic transition. This tightening trend will accelerate as worries about the future persist.
What does this all mean?
We are very late in this economic cycle and lenders are trying to position themselves for the eventual change that is coming. Unfortunately, this pullback by government lenders and banks leads us to the “chicken before the egg” syndrome. The actions taking place now by lenders could exacerbate the next economic cycle or is the next economic cycle exacerbating the lending sector. Only time will tell how this next cycle evolves, but it is clear from the actions of lenders that the cycle is coming one way or the other.
Additional Reading/Resources:
- https://www.bloomberg.com/news/articles/2018-11-15/homebuying-in-greenwich-wells-fargo-wants-a-bigger-down-payment
- https://www.bloomberg.com/news/articles/2018-11-13/curve-inversion-may-lead-u-s-banks-to-tighten-lending-standards?srnd=premium
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Written by Glen Weinberg, COO/ VP Fairview Commercial Lending. Glen has been published as an expert in hard money lending, real estate valuation, financing, and various other real estate topics in the Colorado Real Estate Journal, the CO Biz Magazine, The Denver Post, The Scotsman mortgage broker guide, Mortgage Professional America and various other national publications.
Fairview is a hard money lender specializing in private money loans / non-bank real estate loans in Georgia, Colorado, Illinois, and Florida. They are recognized in the industry as the leader in hard money lending with no upfront fees or any other games. Learn more about Hard Money Lending through our free Hard Money Guide. To get started on a loan all they need is their simple one page application (no upfront fees or other games).