Recently, The American Enterprise Institute (AEI) published an article, First-Time Buyer Mortgage Share and Mortgage Risk Indexes for December 2015. Ed Pinto joins us today from AEI with more on the findings.
Buzz: For those who don’t know, can you describe your background and how you came to be affiliated with AEI.
Pinto: My career in all facets of mortgage lending goes back 42 years, including as Fannie’s EVP and chief credit officer in the 1980s. In 2008 I realized that the truth was not being told about the government’s role in the lead-up to the financial crisis. My experience provided the perspective and data needed to document the government’s key role. That research led me to AEI in 2010, where I now head the AEI Center on Housing Risk.
Buzz: You recently shared, “First-Time Buyer Mortgage Share and Mortgage Risk Indexes for December 2015” on AEI’s website. Can you give a brief synopsis of the findings?
Pinto: First-time buyers continued to increase their presence in the market as both the first-time buyer share and volume were up considerably in December from a year earlier. The December Agency First-time Buyer Mortgage Risk Index showing a significant increase over the prior December.
Buzz: Why do you think there’s been an increase in home sales amongst first time buyers?
Pinto: Increasing leverage combined with a moderately strong economy is fueling this trend. Adding to this demand, pressure was a reduction in FHA’s insurance premium last January. On a year-over-year basis, first-time buyer demand increased in December, continuing the trend of the last 14 months. Strong demand, in combination with shortness of supply, continues to drive home prices up faster than incomes and inflation.
Buzz: What about first time homebuyers can result in a high-risk loan, why do you think that number went up since last year?
Pinto: AEI’s Agency First-Time Buyer Mortgage Risk Index (FBMRI) estimates the share of first-time buyer mortgages that would default in a stress event comparable to the 2007-08 financial crisis based on the actual performance of loans originated in 2007. The Agency FBMRI stood at 15.8 percent in December, up 0.9 percentage point from a year earlier. The Agency FBMRI is now 6 percentage points higher than the mortgage risk index for repeat homebuyers, and the gap between the two series has been growing.
The higher risk for the mortgages taken out by first-time buyers is largely due to risk layering. In December 2015, 70 percent of first-time buyer mortgages had a combined loan-to-value ratio (CLTV) of 95 percent or higher, and 97 percent had a 30-year term. Given the combination of little money down and slow amortization, these buyers will have very little home equity for a number of years unless their house appreciates substantially. In addition, a bit more than one-fifth of first-time buyers taking out mortgages had a FICO score below 660, the traditional definition of subprime mortgages, and slightly more than one-quarter had total debt-to-income ratios above 43 percent, the limit set by the Qualified Mortgage rule. The mortgages taken out by repeat buyers are less risky along two dimensions in particular: a much smaller share had a CLTV of 95 percent or higher and a smaller share had a FICO score below 660.
Buzz: What do you think the statistics you found say about the current state of the housing market?
Pinto: History tells us that in a seller’s market a liberalization of mortgage terms will likely increase both home price and the amount of the debt taken out, even though the monthly debt service remaining approximately unchanged. This is because the liberalization of loan terms easily becomes capitalized in higher prices. As has happened so many times in the past, we are again seeing maximum loan terms become so commonly used that they tend to be considered the minimum. As already noted, 70% and rising of first-time buyers have a down payment of 5% or less. The same trend is happening with debt-to-income ratios. As a result, real home prices are now about 15% higher than the trough in 2012. Eventually, there will be mean reversion and history tells us this will be painful.
Buzz: You mention in the notes section about a seasonal pattern and home sales, could you touch on that some?
Pinto: The National Mortgage Risk Index, the First-Time Buyer Mortgage Share and the Mortgage Risk Indexes (NMRI, FBMSI and FBMRI) are key housing market indicators based on monthly data for nearly all government-guaranteed home purchase loans, which greatly reduces the risk of sample error. By relying on millions of loans, this approach stands in contrast to traditional first-time buyer surveys based on small or incomplete samples of homebuyers or real estate agents.
This robust data set allows us to see clear-cut seasonal patterns on home purchase activity versus volume changes due to economic fundamentals. For example, the seasonal pattern likely reflects the influence of the school calendar. Families with school-age children tend to buy houses in the spring so they can move to their new home during the summer. In most cases, these families are already homeowners, which drives down the first-time buyer share during this part of the year. Because we classify loans by month based on the first-payment date, the sharp decline in the first-time buyer share from June to August corresponds to loan closings that generally occurred between April and June – the height of the spring buying season.
Buzz: Ed, thank you so much for all the great information and for joining us today. If you would like to see the original findings visit AEI’s article here.
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