Since the 2008 housing crash, lenders have overcorrected, shutting out millions of worthy Americans from buying a home.
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How many people should lose their homes to foreclosure?
In an ideal world, of course, there would be no foreclosures at all. Everyone who buys a home would get one that fits their income and needs, and people would have enough money to make their mortgage payments on time and in full. But in a housing market built on debt, foreclosures are a painful reality: People lose their job or fall behind on payments, and lenders are forced to repossess the home to recoup their losses.
Too many foreclosures is obviously a bad thing — losing a home is devastating both financially and emotionally — but it’s also a problem to have too few foreclosures. Low levels of foreclosure activity signal that housing lenders aren’t taking enough risk, locking out hopeful buyers who could have kept up with payments on their mortgage if only they’d been given the chance.
Most residential loans are backed by the government-sponsored enterprises Fannie Mae and Freddie Mac or the Federal Housing Administration. To try to find a happy medium of risk, the GSEs and FHA set a “credit box” to determine who gets a mortgage and who doesn’t. These standards are based on factors including the borrower’s financial stability and the state of the housing market and economy. When the credit box gets tighter, fewer people get mortgages, and foreclosures generally go down. When it opens up, banks take more risks on people with lower credit scores or worse financials, increasing the possibility of foreclosures.
Finding the right size for the credit box is much easier said than done. In the years leading up to the financial crisis of 2008, banks and private lenders handed out millions of risky loans to homebuyers who had no hope of repaying them. A tidal wave of foreclosures followed, plunging the US housing market — and the global economy — into chaos.
But some experts have argued that in the years since the crash, the GSEs, lenders, and regulators overcorrected, shutting loads of potentially reliable buyers out of the housing market. Laurie Goodman, the founder of the Housing Finance Policy Center at the Urban Institute, a nonpartisan think tank, told me there’s room today to “open the credit box” and relax lending standards without pushing the housing market into crisis. More foreclosures might come as a result, she said, but that would be “a worthwhile trade-off” if it gave more people the opportunity to build wealth through homeownership.
Opening the credit box isn’t a cure-all for housing, and given the weakening economy, more cautious experts argue that making it easier to get a mortgage is unnecessary or dangerous. But if it’s done correctly, it could be a major step towards a healthier market. A more stable credit box over time could not only ensure future homebuyers aren’t locked out of getting the home of their dreams, but also smooth out some of the market’s chaotic nature.
The ‘invisible victims’ of the housing market
In the aftermath of the Great Recession, the victims of the housing free-for-all were clear. An estimated 3.8 million homeowners lost their homes to foreclosure from 2007 to 2010, and plenty more did in the ensuing years. But the overly strict lending standards and tighter regulations that followed created a new class of sufferers: people who were unable to join the ranks of homeowners. David Reiss, a professor at Brooklyn Law School, calls these would-be homebuyers “invisible victims” — people who probably could have stayed current on their payments if they’d been approved for a loan but who didn’t get that opportunity.
While the total risk in the housing market grew considerably in the run-up to the foreclosure crisis in 2007, much of that increase was driven by risky loan products rather than a stark change in the quality of borrowers, the Urban Institute argues.
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While it can be hard to know just how many people were locked out of homeownership because of a too tight credit box, a report from the Urban Institute found that in 2015 alone, lenders didn’t make about 1.1 million mortgages that they would have made “if reasonable lending standards had been in place.” Another way to get a sense of just how tight the credit box is right now is to look at the rate of foreclosures. From 2001 to 2003, a period that the Urban Institute considers a relatively “healthy” lending environment, about 0.45% of mortgages entered the foreclosure process each quarter, according to the Mortgage Bankers Association. In 2019, before pandemic foreclosure moratoriums skewed data, the percentage was about half that. Or take the percentage of mortgages at risk of default, where the borrower was likely to fall behind on their payments by 90 days or more: According to an index created by the Urban Institute, this hovered around 12% from 2001 to 2003 and jumped to 17% at the peak of the financial crisis. In the first quarter of 2022, the risk was closer to 5%. All these measures point to the same thing: incredibly high barriers to entry for a loan.
Being locked out of the credit box doesn’t just mean you have to go on renting for a few more years — it also means you’re missing out on the most popular way to build generational wealth in America: owning a home. “We have serious reasons to be concerned about access to credit in homeownership,” Patricia McCoy, a law professor at Boston College who studies financial-services regulation, told me. “When you look at wealth formation in the United States, for most families, the single biggest engine of wealth is home equity.”
A tighter credit box has an outsize impact on lower-income and minority homebuyers, who generally have higher debt-to-income ratios and lower or nonexistent credit scores. A report from Morgan Stanley found that when lenders tightened credit standards at the onset of the COVID-19 pandemic, for instance, mortgage-denial rates increased for minority borrowers with the lowest credit ratings and Black and Hispanic borrowers in the middle credit tier. In contrast, the percentage of white borrowers who were denied loans actually fell over the same period.
How to open the credit box
While lenders have to meet the GSEs’ standards in order to sell them loans, there’s no single definitive credit box — lenders make all kinds of judgment calls as they assess a borrower’s ability to repay the loan, and can narrow the credit box beyond the guidelines at the federal level. They consider a person’s credit score and debt-to-income ratio, as well as how much cash they have for a down payment. Opening the credit box could take different forms, but basically it would entail lenders taking on more risk while still ensuring they’re not handing out reckless loans that set homeowners up for failure.
One of the clearest ways to make this happen would be to relax the standards around credit scores. Last year, according to the Federal Reserve Bank of New York, the median credit score for a mortgage borrower reached a record of 788, well above the national average FICO score of 714. For millennials and Generation X, this baseline for homeownership is even more out of reach — the average FICO scores in 2021 for those generations were 686 and 705. In 2001, more than 30% of mortgage borrowers had FICO scores below 660; in 2020, only 10% of borrowers had a credit score under that number.
Opening up mortgages to people with lower credit scores doesn’t necessarily mean another 2008-style housing bubble will develop. The Urban Institute has argued that while the total risk in the housing market grew considerably in the lead-up to 2007, most of that frothy activity was driven by banks developing risky loan products rather than a stark change in the quality of the borrowers themselves. Goodman added that there are now more resources for homeowners to avoid foreclosure even if they fall behind on their loans. There are also other ways to make sure potentially reliable borrowers don’t slip through the cracks — using alternative credit scores, for example, or considering their utility and rent payment history, which typically hasn’t been reported to credit bureaus.
The benefits of a more stable credit box
Beyond giving millions of Americans the ability to take the first step on the housing-wealth ladder, opening the credit box could have some major benefits for the market more broadly. For one thing, it would reduce the number of people who are forced to rely on renting homes from large investors. As many hopeful buyers failed to qualify for mortgages after the financial crisis, companies that buy up single-family homes and operate them as rentals swooped in to fill the gap. In a white paper published last year, Amherst Residential, which today manages more than 33,000 single-family rental properties, estimated that 85% of its residents would not qualify for a mortgage under the tougher standards. “Although tightening credit boxes and more stringent underwriting standards are typical in post-recessionary mortgage markets, the extent to which credit has been restricted and the duration to which lack of access has persisted is vastly under-appreciated,” it said.
Even just stabilizing the credit box over time could also help smooth out some of the boom-and-bust cycles that have come to define the housing market. In a 2017 paper, McCoy and Susan Wachter from the University of Pennsylvania argued that credit gets too loose in good times and too tight in bad times. A credit box that still adjusts to the market conditions, but does not overreact, would ensure borrowers get mortgages they can afford while also helping to eliminate the highs and lows from the lending cycle and the housing market at large.
“If we do not address this intrinsic cyclicality, the housing market will continue to experience boom-bust cycles, leaving destruction in their wake,” the paper said. “This destruction includes widespread evictions, mass unemployment, severe contractions in credit, depressed homeownership rates, and heightened impediments to wealth formation for minority and lower-income households.”
Not everyone is convinced that opening the credit box is wise, or even necessary
There are, of course, skeptics of credit-box expansion. Mark Calabria, who was the director of the Federal Housing Finance Agency during the Trump administration, told me that while there are plenty of things wrong with the mortgage system today, loosening underwriting standards shouldn’t be on the list of priorities, especially given the slowing growth of — or outright decline in — home values and the weakening economy.
“At the end of the day, putting vulnerable households into a declining asset value right now, when the job market is probably going to weaken, is not simply irresponsible, it’s immoral,” Calabria said.
The real constraint for homeowners today, Calabria said, is finding a home in the first place. By some estimates, the US needs 3.8 million more homes to absorb all the demand for homebuying. He added that expanding credit access would only introduce more buyers who’d then bid up existing homes, worsening the supply shortage.
Mark Calabria, the former director of the Federal Housing Finance Agency, is among those arguing against expanding the credit box right now given the state of the economy. The supply shortage is the true barrier to entry for buyers today, he told Insider.
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McCoy, the Boston College law professor, said that the goal should be to make sure homebuyers are taking on responsible loans and are equipped with the education and resources to keep up with their payments. “We need to think about the back-end risks of homeownership and try to manage that risk and reduce it so that homeownership is a successful experience,” McCoy said. “To me, that is very much intrinsic to opening the credit box — opening it in a way in which homeownership is successful.”
Right now, as the economy is showing signs of weakness, standing pat and preserving the current credit box could help to prevent another extreme swing towards tightening lending standards in the future, McCoy said.”I really push back against the idea that just knee-jerk relaxing credit standards is ultimately a solution,” McCoy said. “When that happens, the danger is that it’s going to saddle people with mortgages that they can’t afford, and they’ll eventually lose their homes. And that does nobody any good at all.” Instead, we should be looking at ways to lower the cost of mortgages and ease zoning laws to build more housing, she said.
Cristian deRitis, the deputy chief economist at Moody’s Analytics, was less wary of opening the credit box. “Improving the financing, making it easier, cheaper, more available — yeah, I’m all for it,” deRitis told me. “There’s certainly ways we can do that in a very controlled manner without going all the way back to where we were prior to the mortgage crisis.” But deRitis also said he doesn’t think expanding the box could move the needle significantly on homeownership or resolve the housing deficit. “That’s basically a supply-side issue,” deRitis said. “So it’s the zoning, it’s the regulations. We just don’t have enough houses out there for people to bid on.”
Goodman, of the Urban Institute, doesn’t see it that way. A household will demand one unit of housing whether they’re renting or buying, she said — just look at the growing market for single-family rental homes. A household’s ability to qualify for a mortgage simply determines whether they’re able to buy or rent, Goodman said. And because mortgages typically last 30 years, she added, risk evaluators should already be considering the possibility of the housing market going up and down during that period. In that sense, a conversation about opening the credit box is valid no matter where we are in the housing cycle.
It’s clear that loosening credit standards won’t be the silver bullet that solves all the housing market’s problems. But ensuring healthy access to credit so that more homebuyers aren’t left behind in the process can be a critical tool to help more Americans get into homes and potentially even ease the constant boom-bust cycle — even if it means taking some more risks along the way.
James Rodriguez is a senior reporter for Business Insider.