When adjusted for the extent home prices have risen since bottoming out after the Great Recession, combined loan-to-value ratios rose above 100% in 2019 for the first time since 2008, according to data in a newly revised working paper, “A Quarter Century of Mortgage Risk.”
Adjusted LTVs are likely even higher now, making mortgages more likely to end up far higher than their actual property values in the event of an economic shock that lowers home prices. Mortgage lenders ideally prefer to qualify borrowers based on a maximum current LTV of 80%.
“Sustained house price appreciation is leading mortgage risk to increase,” the FHFA said in a press release.
To be sure, current forecasts suggest
With forecasts suggesting home valuation gains will slow, prices may never become problematic. Even on a historical basis, shock LTVs haven’t gotten as high as they were during the bubble and the housing market does appear to be softening.
In addition to the finding related to shock LTVs, which the study singled out as most pertinent to the current market, the FHFA researchers also came to a conclusion that may help resolve a debate about the Great Financial Crisis.
Data in the study suggests that the Great Financial Crisis could have started even earlier, during a smaller scale subprime boom-and-bust cycle that occurred in the 1990 rather than with the 2004-2006 housing bubble.
When adjusted for differences in the credit profiles of refinance and purchase borrowers that hadn’t been made in an earlier version of this study, the downward trend in the scores started as early as 1994. That year, the average adjusted score was 711. By 2000, it had fallen to 683. The finding suggests a refinance boom in the early 2000s may have masked credit deterioration during that period.
There was a little bit of a rebound in average credit scores in the early 2000s that may be attributed in part to the bust of a mini-subprime boom that occurred in the 1990s and partially to distortions from the 2003 refinancing boom.
The mini subprime boom was epitomized by the rise and fall of a company called Cityscape Financial Corp., which was known for lending more on the value of collateral than borrowers’ ability to repay. (Regulations that hold lenders’ responsible for borrowers’ ability to repay did not exist at the time.) Lenders briefly pulled back from this market after the company declared bankruptcy in 1998, but scores remained lower than usual. On a net basis, the trend toward looser credit was not reversed. Adjusted scores did not rise above 690 and return to the 700 range until the housing bubble burst in 2008.
The original version of the FHFA’s working paper, first published in 2019, looked at the average basic stressed default rate of purchase loans, which established some trends that the revised report built on using a unique dataset of aggregated numbers from more than 200 million home-purchase and refinance transactions.
The earlier report, for example, does show that the average baseline stressed default rate for all types of purchase loans did start to tick up a little prior to the Great Financial Crisis. While that number peaked for private-label securities at 58.6% in 2006, a similar trend occurred at lower levels for all types of loans tracked, including jumbo mortgages with limits above GSE guidelines, Federal Housing Administration-insured and Department of Veterans Affairs guaranteed products, mortgages held in portfolio, and those purchased by the government-sponsored enterprises.
