So here’s the good news: The national delinquency rate on home loans hit the lowest level it’s been in 18 years as of the final quarter of 2018, according to data compiled by the Mortgage Bankers Association. Borrowers with conventional mortgages, those eligible for sale to investors Fannie Mae and Freddie Mac, are the best performers; roughly 97 percent of them are paying on time. Borrowers with Federal Housing Administration-insured (FHA) mortgages pay late nearly three times more frequently; even so, more than 91 percent of them are on time. The big gap between homeowners with conventional loans and FHA borrowers shouldn’t be surprising, because FHA borrowers have lower credit scores, higher debt-to-income ratios and lower down payments on average. All three factors multiply the risk that borrowers will pay late. Yet even at 8.65 percent, the current FHA delinquency rate is much better than it was a decade ago, when it hovered around 14 percent.
Overall, says Freddie Mac Chief Economist Sam Khater, U.S. homeowners are performing better today in terms of on-time payments and foreclosure avoidance than they have in 30 years.
What’s contributing to this good behavior? It’s no secret: Since 2010, stricter federal underwriting rules imposed on the mortgage industry have banned some of the lending industry’s previous worst habits, and required them to screen out high-risk borrowers — essentially limiting their customer base to people who can truly afford the mortgages they’re seeking. In the conventional market, that’s why Fannie Mae and Freddie Mac — the country’s two largest sources of mortgage money — have kept their average FICO credit scores near a relatively pristine 750, well above levels typical before the financial crisis. (FICO scores run from 300 to 850, with low scores indicating a high probability of future delinquencies and foreclosures.)
An improving economy has helped significantly as well. Mortgage interest rates continue to be below historical averages. Unemployment has fallen steadily and is now at or near multi-decade lows. Plus many of today’s owners are sitting on sizable equity gains as they pay down mortgage balances on their homes while price inflation pushes their values up. The Federal Reserve estimates homeowner equity now totals a stunning $1.5 trillion, the highest ever. For some owners, that cushion functions as an insurance policy should anything threaten their ability to pay the mortgage.
How long can the current impressive performance continue? No one can be certain, but here are a couple of observations. Mortgages originated in the past several years under strict federal rules constitute what lenders and investors call “the cleanest book of business” they’ve seen in many years. If the lending industry begins to relax underwriting standards in any significant way in order to dig deeper into the pool of riskier credit applicants to pump up their volume of home-purchase mortgages, it’s inevitable that delinquencies will rise.
There’s some evidence that a modest loosening of standards got underway last year. Homeowners’ demand for refinancing dissipated with rising interest rates, and some lenders began easing standards to include a broader mix of applicants. FICO itself confirmed in a study that average credit scores were on the decline in the home-mortgage arena. Fannie Mae relaxed its policy on debt-to-income (DTI) ratios for buyers, allowing more applicants with DTIs up to 50 percent to pass muster for a loan. Previously, the cut-off was 45 percent. Meanwhile, the FHA has seen notable declines in average credit scores and is approving low-down-payment purchasers with DTI ratios well above 50 percent.
Steps like these may appear — and be — helpful for marginally qualified first-time buyers. But what will they look like through hindsight during the next recession?