Tag Archives: credit characteristics

The Jumbo/Conforming Spread

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Standard & Poor’s issued a research report, What Drives the Variation Between Conforming and Jumbo Mortgage Rates? It opens,

What drives the variation between the conforming and jumbo mortgage rates for the 30-year fixed-rate mortgage (FRM) product offered in the U.S. residential housing market? While credit and interest rate risk are the main factors at play, S&P Global Ratings explores how these risks relate to capital market execution and whether this relationship translates into additional liquidity risk. In our study, we compare the historical spreads between the two average note rates over time, and we also examine the impact of certain loan credit characteristics. Our data indicate that the rate difference grows in periods for which the opportunity for securitization declines as a viable exit strategy for lenders. (1)

S&P also finds that “[r]isk-based pricing trends also appear to influence the jumbo-conforming spread” and that “[t]he currently narrow spread suggests that a combination of g-fee increases and jumbo credit migration has, to some extent, counteracted the lack of liquidity in the non-agency market.” (1)

The report offers some concise background:

The 30-year FRM is a product unique to the U.S. residential housing market. Lenders in other countries typically offer adjustable-rate or balloon mortgages, which serve as the primary debt tools for housing finance. The 30-year FRM has not been globally adopted, partially because the long-term amortization schedule can saddle a lender with substantial interest rate risk in addition to potentially prolonged credit risk. However, the structure of the mortgage financing system in the U.S. provides an exit strategy: lenders can typically sell loan pools into a reasonably deep market if they are averse to the credit, duration, or convexity risks posed by these long-term assets.

In the U.S., the majority of mortgage financing is channeled through government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac, which have a mandate to buy mortgages for their own portfolios and securitize loan pools, which are subsequently sold to investors. Mortgages that are not financed via the GSEs are often either securitized in the non-agency market or held in institutional portfolios. Both agency and non-agency securitizations optimize funding sources and liquidity, thereby allowing homeowners to enjoy relatively low mortgage rates across the U.S. (1)

My main takeaways from the report are that (1) the decrease in securitization since the financial crisis has contributed to a wider spread between jumbo and conforming mortgages; (2) the high guaranty fee for conforming mortgages pushes down the spread between jumbo and conforming mortgages; and (3) the credit box appears to be loosening a bit, which should mean that jumbos will become available to more than the “super-prime” slice of the market.

Women Are Better Than Men,

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photo by Matt Neale

Greeks vs Amazons, Mausoleum of Halicarnassus, British Museum

at least at paying their mortgages. This is according to an Urban Institute research report that found that

It’s a fact: women on average pay more for mortgages. We are not the first people to have noticed this; a small number of other studies have also pointed it out (e.g., Cheng, Lin, and Liu 2011). One possible explanation is that women, particularly minority women, experience higher rates of subprime lending than their male peers (Fishbein and Woodall 2006; Phillips 2012; Wyly and Ponder 2011). Another explanation is that women tend to have weaker credit profiles (Van Rensselaer et al. 2013). We find that both these explanations are true and largely account for the higher rates.

Looking at loan performance for the first time by gender, however, we find that these weaker credit profiles do not translate neatly into weaker performance. In fact, when credit characteristics are held constant, women actually perform better than men. Nonetheless, since pricing is tied to credit characteristics not performance, women actually pay more relative to their actual risk than do men. Ironically, despite their better performance, women are more likely to be denied a mortgage than men. Given that more than one-third of female only borrowers are minorities and almost half of them live in low-income communities, we need to develop more robust and accurate measures of risk to ensure that we aren’t denying mortgages to women who are fully able to make good on their payments. (1)

This second paragraph undercuts the catchy title of the report, Women Are Better than Men at Paying Their Mortgage, because it is only true when comparing single women to single men and when credit characteristics are held constant.

The report confines its analysis to sole female and sole male borrowers, excluding two-borrower households. This limitation is compounded by the fact that the credit characteristics of men and women are not the same (as men have better credit characteristics as a group).  As a result of these limitations, I think the title of the report goes too far. The authors also acknowledge that the stakes are not that high because the “inequality does not translate into a significant amount that single women overpay for their mortgages: less than $150 per female-only borrower per loan.” (15)

That point aside, the report does raise an important issue about whether credit characteristics metrics are biased against women: “the dimensions we rely on to assess credit risk today do not adequately capture all the differences. This omission has real consequences.” (15) This is certainly true, but lenders will have to carefully navigate fair lending laws as they seek to capture all of those differences.

The State of Predatory Lending

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By U.S. Treasury Department (CFPB Conference on the Credit Card Act, 02/22/2011) [Public domain], via Wikimedia Commons

The Center for Responsible Lending has posted the final chapter of The State of Lending in America: The Cumulative Costs of Predatory Practices. This chapter’s findings include,

  • Loans with problematic terms or practices result in higher rates of default and foreclosure/ repossession. For example, dealer-brokered auto loans, which often contain abusive provisions, are twice as likely to result in repossession as bank- or credit union-financed auto loans.
  • The consequences of default, repossession, bankruptcy, and foreclosure are long-term. For example, one in seven job-seekers with blemished credit has been passed over for employment after a credit check, and borrowers who experience default pay much more for subsequent credit.
  • The opportunity costs of abusive loans are significant. For example, during the same period that subprime loans peaked and millions of families unnecessarily lost their homes, families with similar credit characteristics who sustained homeownership experienced on average an $18,000 increase in wealth per family.
  • Abusive loans have an impact on the economy as a whole. The foreclosure crisis depleted overall housing wealth and led to millions of job losses; predatory practices have been shown to diminish public trust and confidence in the financial system; and there is evidence that student debt is preventing economic growth, especially for young families.
  • Across many financial products, low-income borrowers and borrowers of color are disproportionately affected by abusive loan terms and practices. Families with annual incomes below $25,000– $35,000 are much more likely to receive an abusive loan product. And in most cases, borrowers of color are two to three times more likely to receive an abusive loan compared with a white counterpart. The discriminatory effects of abusive lending clearly contribute to the widening wealth gap between families of color and white families.
  • Loans with problematic terms are repeatedly concentrated in neighborhoods of color. Subprime mortgages and payday loans are two examples. Such concentration leads to a net drain of community wealth and value that could have been spent on productive economic activity and meeting vital community needs.
  • Debt plays a profound role in the financial lives of most American households, with about three-quarters of households having at least one form of debt and many having multiple forms of debt. Indeed, most consumers are not simply mortgage holders, credit card users, payday loan borrowers, or car-title borrowers; they are likely to participate in more than one of these markets, often at the same time.
  • Regulation and enforcement is an effective means for ending lending abuses while preserving access to credit. For example, the Credit Card Accountability and Disclosure Act of 2009 (Credit CARD Act) has continued to give people access to credit cards, while eliminating more than $4 billion in abusive fees and overall saving consumers $12.6 billion annually. (6-7)

The Center for Responsible Lending is a very effective advocate for consumer protection in the financial services industry. That being said, I found it interesting that they were very circumspect in their section on Future Areas of Regulation. (33) They referenced the existing Credit CARD Act, Dodd-Frank Act, state payday lending laws and federal payday lending regulations, but they did not identify any aspects of the consumer financial services market that need additional regulation. Hard to imagine it, but it seems that CRL believes that we have reached regulatory Nirvana, at least in theory.