NEW YORK — U.S. banks are easing credit standards in search of a safe and profitable middle ground after an era of reckless home lending gave way to the stiffest rules in decades, putting a damper on the housing recovery.
Wells Fargo & Co., the biggest U.S. home lender, two weeks ago cut its minimum credit score for borrowers of Fannie Mae- and Freddie Mac-backed loans to 620 from 660. The step followed moves by smaller lenders, such as the U.S. unit of Canada’s Toronto-Dominion Bank, which lowered down payments to 3 percent without requiring mortgage insurance for some loans.
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Banks had ratcheted up borrowing requirements after the most severe housing crash since the Great Depression, preventing as many as 1.2 million loans from being made in 2012, according to an Urban Institute paper. Lenders rode a wave of refinancing until a spike in borrowing costs last year gutted demand, forcing the biggest banks to cut more than 25,000 mortgage jobs. Now they’re removing barriers to mortgages for some borrowers in hopes of reviving a shrinking market.
“We threw the baby out with the bathwater because we had to,” said Rick Soukoulis, chief executive officer of San Jose, California-based lender Western Bancorp. “From there, you start to inch back. If you keep selling only what isn’t selling, you’re just dead.”
In March, credit standards were the loosest in at least two years, according to a Mortgage Bankers Association index. The measure, based on underwriting guidelines, rose to 114 from 100 when it started in 2012. The index would have been at about 800 in 2007, meaning credit was eight times looser that year, before standards were tightened.
Home buyers with higher debt and lower FICO credit scores are now a growing minority among borrowers of loans backed by Fannie Mae and Freddie Mac, the government-owned mortgage giants.
Almost 16 percent of the mortgages for home purchases in March went to borrowers with monthly debt obligations exceeding 43 percent of their pay, according to data compiled by Morgan Stanley. That’s up from 13.4 percent in mid-2012. Federal rules deployed in January expose lenders to liabilities if their mortgages without government backing require payments that, when combined with other debts, exceed 43 percent of the borrower’s income, without proof they can be repaid.
More than 23 percent of the mortgages in March went to property buyers with credit scores less than 720, an above-average measure on Fair Isaac Corp.’s scale that ranges from 300 to 850. That’s an increase from 15.6 percent in mid-2012, according to Morgan Stanley.
After housing values collapsed in 2008, banks raised their credit standards to the highest level in more than two decades. By 2011, the average credit score of an approved mortgage reached 750, according to mortgage processor Ellie Mae. Fannie Mae required only a score of 620 after raising its minimum from 580 in 2009.
“The pendulum swung too far,” said John Taylor, CEO of the National Community Reinvestment Coalition, a Washington- based organization that brings credit and banking services to middle- and low-income consumers. “They over-tightened the standards to the point where qualified borrowers couldn’t get access to credit.”
The banks boosted requirements partly to stem the costs of having to repurchase soured mortgages. As defaults soared, Fannie Mae and Freddie Mac used a clause in their purchase agreements that let them return loans to lenders if they went bad after faulty underwriting.
In 2009, Fannie Mae asked lenders to buy back $12.4 billion worth of mortgages, according to a regulatory filing. The number soared to $23.8 billion in 2012, eating into banks’ earnings, before dropping to $18.5 billion last year, according to filings.
Franklin Codel, head of production for San Francisco-based Wells Fargo, said clearer communication with Fannie Mae and Freddie Mac about underwriting rules is now allowing the bank to widen credit availability.
“We have more confidence that should the loans go into default we’ve done our job properly and we aren’t going to get a repurchase,” Codel said.
While Fannie Mae and Freddie Mac borrowers with lower credit scores must prove the ability to sustain homeownership, Wells Fargo will look for “compensating factors” to close the loan, Codel said. That may include requesting an explanation of a credit history event, reviewing the strength of income and the stability of employment, he said.
Lenders are also relaxing requirements in response to a drop in demand for mortgages. In 2013, a surge in borrowing costs undercut the refinancing boom. Interest rates on 30-year fixed-rate mortgages rose from a record low of 3.31 percent in November 2012 to 4.58 percent in late August, according to Freddie Mac surveys. Rates fell last week to 4.33 percent.
Still, some of the largest lenders aren’t scaling back standards, including JPMorgan, Bank of America Corp., the third-largest mortgage lender, and No. 5 Citigroup Inc., said their spokesmen.
“The regulatory environment now is just so much stricter, there’s not much you can do,” said Brian Simon, chief operating officer of New Penn Financial. “It’s generally not our game plan to chase volume by loosening up on quality.”
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