Low Rates, But Who Can Get Them?

The average rate for a 30-year fixed rate mortgage hit another all-time low last week according to Freddie Mac. Last week’s average rate was 3.49 percent, breaking the 3.5 percent threshold and more than a full point below the 4.55 percent average from a year ago at this time. While the historic rate means great things for affordability, it also appears to be historically difficult to qualify for these record low rates.

Record rates are a boon to consumers. The monthly payment on a $200,000 mortgage at the rate reported by Freddie Mac last week translates into a monthly principle and interest payment of $897 compared to $1,019 last year at this time. That is a savings of $122 per month and more than $13,000 over a 9-year period, the average tenure of a homeowner.

That all sounds great, but the clutch of would-be buyers who qualify for these rates tightened in recent years. Based on data provided by Amherst Securities [1] and Ellie Mae, the current average [2] FICO scores on loans (originated) by the FHA was 707 in May, which is an improvement from 2011 when the rate averaged 709. However, the average FICO score for a denied loan application was 669 in May, well above the 656 average for originated loans back in 2001 and above to the 660 [3] mark used by the Office of the Comptroller of the Currency (OCC) to delineate prime loans.

Likewise, standards on conventional loans, those financed at Fannie Mae and Freddie Mac, increased from an average of 711 in 2001 to an average of 765 in May of this year. What’s remarkable is that the average FICO of a rejected purchase application was 724 in May, well above the average FICO of an originated loan back in 2001.

Data for average characteristics of mortgages that are originated do not offer a full picture of the tightness of underwriting. However, the data from Ellie Mae which provides insight into the characteristics of denied loan applications delivers more insight into how tight overall underwriting standards are. It may be the case that the average FICO does not account for other factors that disqualify a borrower such as a low downpayment, difficulty documenting income (e.g. workers without payroll stubs like consultants or contractors) or high debt-to-income (DTI) ratios. However, a high average FICO for denials would suggest limitations on underwriters’ ability or willingness to take into account mitigating circumstances for low downpayments or high DTI ratios during the origination process.

Finally, the high average FICO of denied applicants suggests an impact on would-be mortgage applicants. Tight underwriting standards may already have signaled to less creditworthy borrowers that they are likely to be rejected and thus they may not apply for loans. Likewise, credit overlays such as the GSE’s loan level pricing adjustments may also preclude would-be applicants with less than pristine credit, high DTIs like first-time buyers, or small downpayments from applying for loans as these charges result in higher upfront costs or higher effective mortgage rates.

Tight underwriting in the current environment comes as little surprise to most practitioners. This data provides better insight to how current underwriting compares historically and more importantly it provides insight into the quality of borrowers that are being denied. While home sales have experienced their strongest spring in years, the over correction in lending standards is holding the housing market back from a robust recovery.

[2] Weighted averages for both denied and originated loans at the FHA and GSEs were created using purchase and refinance originations weighted by the national shares reported by Ellie Mae. Consequently, the estimates may slightly understate the FICOs of the GSEs because of the high current share of GSE refinance volumes.

[3] http://www.occ.treas.gov/publications/publications-by-type/other-publications-reports/mortgage-metrics-2012/mortgage-metrics-q1-2012.pdf