A 23-year-old article from a Florida newspaper grabbed the attention of a packed room of executives at the Mortgage Bankers Association’s National Secondary Market Conference & Expo last week – because the story it told sounded so similar to today’s headlines.

The article, entitled “Family Abandons American Dream, Mails in Keys to Home,” told of a family whose home went into foreclosure when the husband lost his job. By the time he found a new one, they decided they’d lost too much equity in their home to make keeping it worthwhile.

The lessons from close to a quarter-century ago hold true now, according to Fannie Mae Senior Vice President for Credit Policy and Risk Management Marianne Sullivan, who offered the article to demonstrate that point.

“Tighter underwriting standards and safer loan products” – remedies cited by another Fannie Mae executive who used the article in a presentation in 1985, according to Sullivan – are “the same keys [needed for] recovery today,” she said.

Freddie Mac is working to mitigate risk by no longer offering 100 percent finance loans except under certain affordable housing programs, and only then to borrowers with a minimum 700 credit score, according to Connie Ferran, the agency’s vice president for customer credit management.

“We’re lowering loan-to-value ratios, increasing [minimum required credit scores], and requiring more documentation,” she said.

“We’ve had these experiences before,” she added, indicating that the current housing credit crunch is comparable to past downturns, although this time around, Freddie Mac is paying more attention to borrower-based risk.

Freddie is the other government-sponsored loan purchaser that, along with Fannie, saw its market share of loans purchased double between 2006 and 2007 as Wall Street investors dropped out of the picture.

Last fall, both agencies also started charging borrowers with credit scores below 680 a small, risk-based fee to purchase their loans. In June, the minimum score will rise to 720.

But in today’s market – where according to predictions at last week’s conference, home values will continue to drop for at least another year – struggling homeowners are still considering walking away from homes they can’t afford.

‘Short-Term’ Thinking

Alvaro Ramirez, business development director for the San Jose, Calif.-based Homeowner Rescue Alliance, a for-profit, lender-funded company that helps borrowers work out loan modifications, told Banker & Tradesman that about 40 percent of the 300 attendees at a recent foreclosure prevention workshop sponsored by his company said they were considering walking away from their homes and their mortgages because they could buy a cheaper, short-sale or foreclosed upon property elsewhere and reduce their monthly payments.

The values of these borrowers’ homes had dropped between 40 percent and 60 percent in the past year, Ramirez said.

And while a foreclosure can lower a borrower’s credit score significantly, it doesn’t show up on a credit report immediately – and disappears within seven to 10 years.

Borrowers who want to leave a home behind because the value has dropped are thinking “short-term,” Ramirez said, despite HRA’s advice that they’ll ruin their credit if they walk away.

Other observers agree.

One industry official, who asked not to be identified because he was offering a personal opinion, said people who have a foreclosure on their credit history could have trouble getting a college loan for a child, financing a car purchase, getting a job at a company that check potential employees’ credit histories, and even renting an apartment.

Peter Milewski, mortgage insurance program director at MassHousing, a quasi-state agency that funds and insures affordable home loans, said today’s foreclosure and credit crunch crisis can be traced, in large part, to consumers who got mortgage credit more easily than their lower credit scores warranted.

Now that home prices are dropping for the first time in 15 years, he said, they can no longer refinance, and face foreclosure – or may choose to let it happen.

Deliberately defaulting on a mortgage loan is not illegal, Milewski noted, but rather a breach of civil contract. While a lender could sue a borrower who took such an action, some might be overwhelmed by the potential number of people they could sue for that type of breach, he said.

Milewski, who has worked in the mortgage risk industry since 1981, said a borrower’s credit score is now, and always has been, the best indicator of whether the borrower is willing and able meet his or her financial obligations.

MassHousing has an extremely low default rate on its loans, he said, because the average credit score of its borrowers is 720.

The average Massachusetts resident has a credit score of about 700, he said, which ranks the state among the highest averages in the nation.
Gail Cunningham, spokeswoman for the National Foundation for Credit Counseling, later said borrowers should think about negotiating a short-sale agreement with their lender or allowing a foreclosure to take place only if they know they cannot maintain a house payment for the long term.

But many borrowers can and should ride out the low end of the current housing cycle as they have in the past, she suggested.

Declining home values have no bearing on homeowners, unless they have to move and sell the home, Cunningham said, noting that, “Housing cycles are a reality.”

Indeed, Sullivan said the first of nine “truths” of American home financing Fannie Mae has identified is that “housing cycles happen.”
There have been eight housing market recessions in the past 50 years, she added, and there will inevitably be more down the road.

Like Freddie Mac, Fannie Mae will purchase few, if any, 100 percent finance loans anymore, Sullivan said.

“[Another] ruthless truth still applies: Skin in the game matters,” she noted.

But Fannie Mae hasn’t dismissed backing loans of borrowers who don’t fit more traditional credit profiles, Sullivan said.

“Stretch lending is progress,” she said. “The future of housing equality lies in extending credit” to people with slightly lower scores, or less money down.

“That doesn’t necessarily mean sleazy credit,” Sullivan noted.
Investment banks are not much in the mortgage-loan purchase business these days, but they’re still watching – and deciding when and how to return.

During another panel at the MBA conference, Laurie Goodman, managing director at UBS, a Swiss investment bank in New York, predicted that “simpler structures and better documentation” will be the hallmarks of mortgage-backed securities when they re-emerge.

Last Monday’s conference was held by the Washington, D.C.-based MBA at the Hynes Convention Center in Boston.