Almost five years after banks – burned by bad mortgages and the imploding housing market – clammed up on credit, lending conditions still remain tight, stunting further improvement in the housing market.
So when does it end? When do banks finally start lending gain?
A lot of the current credit issues have to do with the deluge of refinancing lenders have been hit with thanks to historically low interest rates.
"When refinancing demand is high, lenders have less incentive to pursue harder-to-complete or less profitable loan applications," Federal Reserve Gov. Elizabeth Duke said in a recent speech to the Mortgage Bankers Association. "In the current environment, refinance applications by high-credit-quality borrowers are likely the easiest to complete."
"It is possible that the abundance of these applications may have had the unintended effect of crowding out borrowers with lower credit scores, whose applications may be more time consuming to process," Duke added.
Keith Gumbinger, vice president of mortgage information site HSH.com, agrees, saying there's a direct correlation between today's tight underwriting standards and a slack in purchase demand.
"If you were a lender, which loan would you pursue: an existing customer with a perfect payment history looking to refinance, or a young, first-time buyer with less than stellar credit?" Gumbinger says.
But once refinances dwindle to the point that originations slow, lenders will once again need to attract purchase customers, a large portion of which comprise first-time homebuyers. Lending conditions will certainly need to ease in order for that to happen since young, first-time buyers tend to have lower credit scores and student loan debt.
While certainly an increase in purchase activity will help ease standards, lending conditions won't seriously change until three other changes take place:
1. Fannie and Freddie ease their standards: Since they make up such a large portion of the market, we won't see widespread change until Fannie and Freddie decide to ease their standards. But that may be difficult, since tight standards mean more profitable loans, and more profitable loans mean paying back taxpayers for the $116 billion bailout more quickly.
2. Increased role for the private market: Increased participation by the private mortgage market means more competition for the same loans and even new and different loan products to choose from. Increased private market participation in the jumbo market has also led to cheaper borrowing costs on large loans.
3. Resolving uncertainties surrounding regulation: With portions of Dodd-Frank Wall Street Reform Act not even fleshed out and the upcoming implementation of the Qualified Residential Mortgage (QRM) definition, lenders are skeptical about what the future of the market will look like and how it will influence their ability to make money. A clearer picture on the new rules governing the mortgage industry would go a long way in making lenders more comfortable about writing new home loans.
So while there's no one factor that will be responsible for easing lending conditions, pay attention to refinance applications and activity. A significant falloff in refinances and an upswing in purchase activity will likely signal looser conditions are starting to happen.
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Tim Manni is the Managing Editor for HSH.com, and is also one of the authors of their daily blog, which concentrates on the latest developments in the mortgage and housing markets. Tim's work with HSH.com has been featured in several other media outlets, including the Wall Street Journal, MSN Real Estate, Forbes and MarketWatch.com.