Loosening mortgage standards entails risks

A recent Fannie Mae news release outlined a new program, the HomeReady mortgage, “an innovative lending option aimed at helping creditworthy borrowers with lower and moderate incomes have access to an affordable, sustainable mortgage.”

Here is the part of the news release that got our attention:

“For the first time, income from a non-borrower household member can be considered to determine an applicable debt-to-income ratio for the loan, helping multi-generational and extended households qualify for an affordable mortgage … Other HomeReady flexibilities include allowing income from non-occupant borrowers, such as parents, and rental payments, such as from a basement apartment, to augment the borrower’s qualifying income.”

So now with as little as 3% down, and income from a “non-borrower household member” or “non-occupant borrowers, such as parents, and rental payments,” you can qualify for a Fannie Mae-backed mortgage!

We’re all familiar with the prudent caution concerning co-signing on a loan (i.e., legally becoming party to a transaction in which you have no primary interest). The HomeReady Program seems like the antithetical corollary, in that the lender (Fannie Mae) is going to base a loan approval upon income from parties with whom it has no legal recourse.

How is this prudent lending? And if the cycle of lowering lending standards set forth by the government prior to the financial crisis of 2008 led to imprudent lending, then what is this type of lending going to produce?

Certainly, the goal of expanding home ownership is an admirable one. The tax deductibility of home mortgage payments is a prime incentive and it has had its intended effect. Despite all of the turmoil in the housing market, approximately two-thirds of Americans own their own homes. Indeed, home equity is often the largest asset owned by families and increasingly is relied upon as a source of income during retirement.

RAISE INCOMES

The desire to expand home ownership clearly drove the decline in mortgage lending standards prior to the financial crisis of 2008. However, if policymakers want to increase home ownership, they should be implementing programs to raise incomes and living standards. You simply can’t make someone creditworthy by lowering standards. This is akin to simply setting a lower passing score if not enough students are earning a passing grade.

Advisers should be aware of clients who may be overextending themselves or have family members who are overextending themselves — just because something is permissible doesn’t make it advisable. They also should be aware that as lending standards deteriorate, markets may become overheated and the inevitable correction will likely be painful. 

We believe that policymakers should heed the words of Nobel laureate economist Milton Friedman, who so aptly pointed out, “One of the great mistakes is to judge policies and programs by their intentions rather than their results.”

Robert R. Johnson is president and CEO of The American College of Financial Services, and Anthony Hendrickson is dean of Heider College of Business at Creighton University.