The Government Creates Another Housing Bubble

Loose mortgage terms are pushing home prices up. Underwriters need to tighten standards.

By Paul Kupiec and Edward Pinto

A sold sign displayed in front of a house in Sacramento, Calif., July 5, 2017. Photo: Rich Pedroncelli/Associated Press

Home prices are booming. So far, 2018 has posted the strongest growth since 2005. “About 60% of all U.S. metros saw an acceleration in the rate of price increases through February this year,” according to Housing Wire. Since mid-2012, real home prices have increased 28%, according to data from the American Enterprise Institute. Entry-level home prices are up about double that rate. In contrast, over the same period household income has barely kept pace with inflation. The current pace of home-price inflation is increasing the risk of another housing bubble. 
The root of the problem is declining underwriting standards. In April Freddie Mac announced an expansion of its 3% down-payment mortgage, the better to compete with the Federal Housing Administration and Fannie Mae . Such moves propel home prices upward. Because government agencies guarantee about 80% of all home-purchase mortgages, their underwriting standards guide the market.

Making lending even more dangerous, CNBC recently reported that “credit scores may go up” because new regulatory guidance allows delinquent taxes to be excluded when calculating credit scores. These are only some of the measures that “expand the credit box” and qualify ever-shakier borrowers for mortgages. 
During the last crisis, easy credit led home prices to rise at an unsustainable pace, leading marginally qualified borrowers to stretch themselves thin. Millions of Americans’ dreams became nightmares when the housing market turned. The lax underwriting terms that helped borrowers qualify for a mortgage haunted many households for the next decade.

As many as 10 million families lost their homes to foreclosure during the recession and housing crisis, according to Pew. This happened despite federal programs that modify mortgage payment terms to prevent foreclosure. While the home-price bubble affected homes at all price levels, the largest percentage gains and subsequent declines occurred in lower-priced markets.

Minorities were disproportionately affected. A 2017 Federal Reserve study found that the housing boom-bust cycle had an exaggerated negative effect on the wealth of black and Latino households. And a 2014 study by the Urban Institute showed that these same minority groups have been slow to recover as household losses and tainted credit continued to depress postcrisis minority homeownership rates.

Mortgage underwriters need to tighten standards before it’s too late. Fannie Mae, Freddie Mac and other government-sponsored enterprises should immediately require at least 5% down on 30-year conventional mortgages. They also should reinstitute a debt-to-income limit of 45% and stop guaranteeing loans on vacation and rental properties. The government-sponsored lenders should also avoid high-balance loans while limiting guarantees for most cash-out refinancing mortgages.

The FHA’s original mandate was to assist lower-income Americans with buying their first home—a goal worth sticking to. The FHA should require at least 3.5% down on 30-year mortgages and limit seller concessions—cash back from the seller at closing—to 3%, since such concessions artificially inflate home-sale prices. The agency also should limit the debt-to-income ratio to 50% and require loans in excess of the Consumer Financial Protection Bureau’s 43% maximum to satisfy a residual-income test. FHA guarantees for cash-out refinance mortgages can be done away with. 
The current unsustainable pace of home-price inflation can be stopped only by damming the flood of government mortgage credit. Imposing prudent underwriting standards will improve home affordability, head off a new wave of mortgage foreclosures, and protect the most vulnerable Americans.

Mr. Kupiec is a resident scholar at the American Enterprise Institute. Mr. Pinto is a co-director of AEI’s Center on Housing Markets and Finance.

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