By Ray Birch
PLANO, Texas—With homeownership getting further out of reach for a growing number of Americans, one economist is expressing concerns that lenders may take greater risks with new types of loans to get more borrowers under roof, especially if a housing market correction occurs.
As CUToday.info reported, for example, Noble Credit Union is offering a 40-year mortgage and United Wholesale Mortgage has introduced a no downpayment loan.
Brian Turner, president and chief economist of Meridian Economics, shared with CUToday.info why he believes the new offerings have hit the market and why he believes extra scrutiny is needed.
“These products, especially the 40-year mortgage, are likely happening for the same reason we have ventured so far away from four-year vehicle loans—to make mortgage payments appear to be more affordable,” said Turner. “But it’s not really that much in monthly savings, given the risk to both lender and borrower. Consider this: a monthly principal-and-interest payment on a $300,000 loan at 7% for 30 years is $1,995; at 7.25% for 40 years it’s $1,919, and at 7.30% for 50 years is $1,874. In the meantime, the borrower assumes more gap exposure between the value of the loan balance and the lender experiences greater exposure between collateral value and loan balance.”
Turner agreed zero downpayments and the longer terms are signs that affording a home is becoming difficult for many Americans.
“It certainly is for first-time home buyers who generally account for 40% of total buyers—and that statistic recently dropped to less than 30%,” said Turner. “‘Turner’s Home Lending’ theory has been that people don’t buy their homes based on market value, but based on monthly mortgage payment. If they have a budget of $1,500 per month, then at 7% they can afford a $225,000 home. However, at 5% their affordability capacity climbs to $280,000. Both of these are well-below the average home prices for either new or existing home sales—$433,000 and $408,000, respectively.”
Hurdle Gets (Much) Higher
Turner further noted the average household income requirements to secure financing has nearly doubled in the past few years.
“For someone making $65,000 per year, under basic underwriting rules, the applicant would be able to secure up to $180,000 in financing,” he said. “If partnered with a spouse or another person, a combined income of $120,000 can comfortably increase one’s financing capacity to $360,000. But, once again, pretty far from the current average sales prices. So, big down payments, second liens, or other options would be needed.”
Turner said a big problem with extending beyond a 30-year term is that doing so brings the same risk elements that occur after extending vehicle loan terms to 60, 72 and now, often 84 months.
Brian Turner
“The longer the term, the longer it takes to reach a balance between collateral values and loan balances,” he reminded. “That’s why the 48-month vehicle loan term was ideal—it followed more closely the dilution in market value over time. But with 60-plus-month terms, the lender must hold and keep current vehicle loans up to 85% of its original term just to reach that balance between the two. This obviously doesn’t serve the borrower because it creates additional gap exposure, which in turn doesn’t serve the lender’s risk exposure for potential loss.”
A Bubble, A Burst
Previously, Turner pointed out, few borrowers had to worry about home values decreasing during ownership.
“That is until 2008, when the home financing market was turned on its head, with values dropping 27% from their previous peak,” Turner explained. “Now values have increased 70% from their 2006 peak. But, more remarkably, they have increased more than 135% from their 2012 trough. So, it seems very reasonable that home sales at these relatively high values over the past two years alone, being financed at mortgage rates that have more than doubled since 2021, creates a potential credit risk that could lead to near-term losses should a market correction occur. Remember, average home values have increased 32% since 2021, faster than even consumer inflation’s elevated pace of 21%.”
Home sale prices have increased 11% since December 2022 alone, during a time when the average 30-year mortgage rate increased from 6.35% to 7.05%, Turner noted.
“Moreover, credit union real estate assets—namely first-lien residential loans—have increased 8%, and account for 53% of total loans,” Turner said. “From 2021 to early 2022, mortgage rates averaged 3.25%, but real estate loans increased 9%. Therefore, the industry loaded up quite a number of low-rate, longer-term loans on their books during a short period of time. The same can be said for vehicle loans, although their shorter-term profile is of less risk exposure. As I have said many times, this helped to contribute to the current liquidity crisis—damaged further by inflation’s effect on members’ paycheck-to-paycheck existence and the volatility of core deposits.”
What Might Lie Ahead
What does this suggest for the mortgage market’s future?
“It implies that we will be seeing great volatility in the mortgage market going forward, both in terms of market demand and credit mitigation objectives,” Turner answered. “People talk about the volatility of mortgage rates, but the industry must pay more attention to relative pricing spreads they are receiving by taking on the longer-term credit risk.
“For instance, prior to the 2008-09 Great Recession, the average pricing spread of a 30-year mortgage was around 150 basis points,” he continued. “After the recession began, the collapse in financing rates also led to pricing spreads—the value received by taking on the credit risk—climb to 300 basis points. As the economy improved, financing rates rose again but the pricing spread declined to about 100 basis points.”
Increase in Spreads
The recent increase in mortgage rates has also brought an increase in spreads to around 250 basis points, Turner noted.
“So, lenders—not withstanding loss exposures—are enjoying higher financing rates with relatively higher pricing spreads,” he said. “That, as an economist, is troubling and implies a potential correction is needed within the market.”
Turner advised credit unions to not try to become a “latter-day savings and loan association” by always maintaining a high level of real estate loans, both residential and commercial.
“As noted, real estate loans account for 53% of total loans,” Turner said. “This at a time when we are already seeing an increase in loan portfolio delinquency and the number of foreclosures and foreclosure filings more than double compared to 2023.”
The No Downpayment Product
What about the no-down payment mortgage being offered by United Wholesale Mortgage, one of the country’s largest mortgage lenders?
“Real estate loan allocation within the balance sheet already presents a certain challenging outlook as to credit mitigation and liquidity risk,” Turner said. “I’m not as concerned about interest rate risk, notwithstanding a major challenge coming from delinquencies and foreclosures. But any extension in mortgage terms—namely 40 or 50 years—is not recommended because of the risk elements that would adversely contribute to the credit union’s overall enterprise risk exposure.”