The Bifurcation of American Housing

I found this chart recently and found it fascinating. It looks at mortgage originations by credit score over time:



In the past we had far more mortgages given to those with credit scores below 760. Why is this important? It means that those of modest means and modest income aren't getting mortgages. Now, you may say that's great, as there will be far fewer foreclosures. And that is true, but it leads to a problem: only the very well off can afford mortgages. And what does that do?

Let's look at a city that has lots of low cost properties. Take a look at the ratio of home prices to prevailing rents:



There's something funny going on there with lower priced homes. Prices are only 4-8x the rent, while they are between 10-12x the rent for higher priced properties. Given that a ratio of 4-8x means that those homes are a steal, why aren't renters simply buying the properties?

The problem is that they cannot. With Dodd-Frank regulations and the CFPB, mortgages to people who would be buying these homes (low income, low credit score) are effectively banned. Now understand that this happens for a reason, these loans are more likely to fail and those who take out the mortgages more likely to declare bankruptcy, so there is a good side to this. Additionally, funding these types of loans becomes expensive because of the income verification and other regulations that have to be complied with. But what's the downside? The only people who can buy these properties are those who qualify, those who have enough money to simply buy them. This is effectively cutting out competition for landlords. They can buy homes for cheap and rent them out for relatively high rents.

And this is really the source of much of the rental affordability problem. Look at rental affordability over time:



Something broke in 2010, and this is it. Dodd-Frank was instituted, and landlords were shielded from competition.

Now understand, I'm not necessarily against this, but there is a problem right now. Real interest rates are very cheap relative to inflation, and so landlords can essentially buy these homes for free with the way rental inflation is happening. The poor are stuck with paying these rents because they have no way of buying the properties, and so the rent/income ratios balloon.

So what is the solution? To me, I see only two possibilities: either we repeal Dodd-Frank and allow banks to again make these risky loans, or we try to get interest rates higher so that it isn't as cheap for landlords to buy up property (additionally we could eliminate things like mortgage interest deductions and landlord tax breaks). The former will make home prices rise, while the latter will make home prices decrease. I prefer the second, but is it politically possible? I'm not sure.

Either way, the current setup isn't working, and it needs a drastic change.

If you want to read a more in depth analysis from someone who thinks credit ought to be expanded, take a look here:

https://idiosyncraticwhisk.blogspot.com/2018/04/housing-part-293-how-has-dodd-frank.html

phattonez said:

I found this chart recently and found it fascinating. It looks at mortgage originations by credit score over time:


In the past we had far more mortgages given to those with credit scores below 760. Why is this important? It means that those of modest means and modest income aren't getting mortgages. Now, you may say that's great, as there will be far fewer foreclosures. And that is true, but it leads to a problem: only the very well off can afford mortgages. And what does that do?

Click to expand...

I don't buy that, you don't have to be wealthy to have a good credit score -- you just have to pay your bills. A low credit score isn't an indicator of income level but rather of financial responsibility.

The problem is that they cannot. With Dodd-Frank regulations and the CFPB, mortgages to people who would be buying these homes (low income, low credit score) are effectively banned. Now understand that this happens for a reason, these loans are more likely to fail and those who take out the mortgages more likely to declare bankruptcy, so there is a good side to this. Additionally, funding these types of loans becomes expensive because of the income verification and other regulations that have to be complied with. But what's the downside? The only people who can buy these properties are those who qualify, those who have enough money to simply buy them. This is effectively cutting out competition for landlords. They can buy homes for cheap and rent them out for relatively high rents.

Click to expand...

Again, the two are not synonymous.

Now understand, I'm not necessarily against this, but there is a problem right now. Real interest rates are very cheap relative to inflation, and so landlords can essentially buy these homes for free with the way rental inflation is happening. The poor are stuck with paying these rents because they have no way of buying the properties, and so the rent/income ratios balloon.

Click to expand...

They're not buying them for free -- good grief -- they're buying them for the negotiated price, which is often quite steep. Also, many buy with cash so interest rates mean nothing to them.

So what is the solution? To me, I see only two possibilities: either we repeal Dodd-Frank and allow banks to again make these risky loans, or we try to get interest rates higher so that it isn't as cheap for landlords to buy up property (additionally we could eliminate things like mortgage interest deductions and landlord tax breaks). The former will make home prices rise, while the latter will make home prices decrease. I prefer the second, but is it politically possible? I'm not sure.

Click to expand...

Making subprime loans is out of the question -- it led to the last housing bubble and the burst took all of us down with it. As I said many purchases are cash so eliminating mortgage interest rate deductions would only be a holdback to those who are buying their own homes. What kind of "landlord tax breaks" are you talking about? Any money spent in running a rental business is deductible against the profit. What (specifically) would you change?

If you really want to see folks in their own homes, stress as soon as high school not to take on debt for fast cars, athletic shoes, iPhones and the like. Teach kids not to charge what they can't afford and teach them to save some money from EVERY paycheck for a down payment.

It's not that hard.

Thanks for the interesting discussion. I'll just comment where something catches my eye.

phattonez said:

I found this chart recently and found it fascinating. It looks at mortgage originations by credit score over time:

In the past we had far more mortgages given to those with credit scores below 760. Why is this important? It means that those of modest means and modest income aren't getting mortgages.

Click to expand...

I don't see the connection between credit score and income levels, except perhaps at the very lowest income levels.

Given similar downstrokes, one's credit score is the determinate of creditworthiness. Income may determine one's loan amount, but that is predicated upon a good credit score. Without creditworthiness, income means nothing.

Now, you may say that's great, as there will be far fewer foreclosures. And that is true, but it leads to a problem: only the very well off can afford mortgages. And what does that do?

Let's look at a city that has lots of low cost properties. Take a look at the ratio of home prices to prevailing rents:

There's something funny going on there with lower priced homes. Prices are only 4-8x the rent, while they are between 10-12x the rent for higher priced properties. Given that a ratio of 4-8x means that those homes are a steal, why aren't renters simply buying the properties?

The problem is that they cannot. With Dodd-Frank regulations and the CFPB, mortgages to people who would be buying these homes (low income, low credit score) are effectively banned. Now understand that this happens for a reason, these loans are more likely to fail and those who take out the mortgages more likely to declare bankruptcy, so there is a good side to this. Additionally, funding these types of loans becomes expensive because of the income verification and other regulations that have to be complied with. But what's the downside? The only people who can buy these properties are those who qualify, those who have enough money to simply buy them. This is effectively cutting out competition for landlords. They can buy homes for cheap and rent them out for relatively high rents.

And this is really the source of much of the rental affordability problem. Look at rental affordability over time:

Something broke in 2010, and this is it. Dodd-Frank was instituted, and landlords were shielded from competition.

Now understand, I'm not necessarily against this, but there is a problem right now. Real interest rates are very cheap relative to inflation, and so landlords can essentially buy these homes for free with the way rental inflation is happening.

Click to expand...

I'm not sure what you mean by "free"?

If you mean free in that the home's rate of appreciation is similar to the investment potential of the purchase funds, then you're overlooking taxes, utilities, and maintenance.

If you mean the tenant's rent pays the landlord's mortgage, well that's been status quo for a long time. Property appreciation & capturing equity is the profit the owner shows for his risk, efforts, and the opportunity cost for his downstroke (which is usually 20% min for rental properties).

The poor are stuck with paying these rents because they have no way of buying the properties, and so the rent/income ratios balloon.

So what is the solution? To me, I see only two possibilities: either we repeal Dodd-Frank and allow banks to again make these risky loans, or we try to get interest rates higher so that it isn't as cheap for landlords to buy up property (additionally we could eliminate things like mortgage interest deductions and landlord tax breaks). The former will make home prices rise, while the latter will make home prices decrease. I prefer the second, but is it politically possible? I'm not sure.

Either way, the current setup isn't working, and it needs a drastic change.

<edited for brevity>

Click to expand...

What I saw in your first graph (credit scores) was a clear example of why the recent real estate crash occurred: An abundance of new homeowners who were not creditworthy for their purchase.

I'm not going to deny that home ownership is becoming more difficult for many Americans, and that trend needs to be reversed. But I see this as symbolic of the growing wage disparity in this country, along with the disappearing middle-class.

I'm not sure what the solution is, but I do not believe it is to give mortgages to those who are poor risks, as was done going into the recent crash.

HowardBThiname said:

I don't buy that, you don't have to be wealthy to have a good credit score -- you just have to pay your bills. A low credit score isn't an indicator of income level but rather of financial responsibility.

Click to expand...

This is a symptom of the problem, not the problem itself. The reason that poor credit scores are getting fewer mortgages isn't because of the credit score itself. It's because people with lower incomes have lower credit scores, and it's people with lower incomes who are squeezed out of getting mortgages with these regulations.

Again, the two are not synonymous.

Click to expand...

In theory, no. In practice, yes.

They're not buying them for free -- good grief -- they're buying them for the negotiated price, which is often quite steep. Also, many buy with cash so interest rates mean nothing to them.

Click to expand...

Yes, it's not actually free. I'm just saying that when your interest rate is near consumer inflation and below rent inflation, and when the prevailing rent can pay off the mortgage in just a few years (not even counting the interest rate deduction and landlord write offs), it's an incredible bargain. You're getting cash flow at very low risk. Normally in this situation home prices would be bid up. Why aren't they? Because the people who want to live in these homes are excluded from taking out the mortgages.

Making subprime loans is out of the question -- it led to the last housing bubble and the burst took all of us down with it. As I said many purchases are cash so eliminating mortgage interest rate deductions would only be a holdback to those who are buying their own homes. What kind of "landlord tax breaks" are you talking about? Any money spent in running a rental business is deductible against the profit. What (specifically) would you change?

Click to expand...

Many of those cash offers are loans taken against some other property, just not the property you're intending to buy. There is still leverage involved. As for the tax breaks, there's the mortgage interest deduction, depreciation, insurance premia, management fees, travel, etc. There are a ton of tax breaks that cut down the cost of being a landlord.

If you really want to see folks in their own homes, stress as soon as high school not to take on debt for fast cars, athletic shoes, iPhones and the like. Teach kids not to charge what they can't afford and teach them to save some money from EVERY paycheck for a down payment.

It's not that hard.

Click to expand...

This isn't the problem. Mortgages for small amounts are now harder for those with low incomes to qualify for because of the "ability to repay" rule. Further, even if you do qualify, these loans are now very expensive to close. See the following:

Jack Hartings said:

Applying the QM standards to low dollar loans in particular often yields perverse results. Consider, for example, a $75,000 loan with an 80 percent loan-to-value ratio and a cash-out feature to a customer with a lower credit score. Low dollar loans with these characteristics are common in many parts of the country for purchase or refinance. This is a conforming loan that I could sell to Freddie Mac, and doing so would make it (by definition) QM. But selling this loan to Freddie Mac would cost the borrower over $4,100 in Freddie Mac fees alone and approximately $5,500 in total fees. No borrower wants to pay over 7.3 percent in closing fees. In the past I would accommodate this customer, who could be a good credit risk, by holding the loan in my portfolio, thereby avoiding the Freddie Mac fee. But my closing fee would still, of necessity, exceed $3,000, which is the ceiling on QM loans in this dollar range. With the QM rule in the effect, the only way I can serve this customer is by selling the loan and charging a significantly higher fee. Paradoxically, the fee cap will cause this customer to pay a higher fee for a Freddie Mac loan, or to lose access to credit altogether.

Click to expand...

https://financialservices.house.gov/uploadedfiles/hhrg-113-ba15-wstate-jhartings-20140114rev.pdf

Chomsky said:

Thanks for the interesting discussion. I'll just comment where something catches my eye.

I don't see the connection between credit score and income levels, except perhaps at the very lowest income levels.

Given similar downstrokes, one's credit score is the determinate of creditworthiness. Income may determine one's loan amount, but that is predicated upon a good credit score. Without creditworthiness, income means nothing.

Click to expand...

And this is exactly where the problem is.

I'm not sure what you mean by "free"?

If you mean free in that the home's rate of appreciation is similar to the investment potential of the purchase funds, then you're overlooking taxes, utilities, and maintenance.

If you mean the tenant's rent pays the landlord's mortgage, well that's been status quo for a long time. Property appreciation & capturing equity is the profit the owner shows for his risk, efforts, and the opportunity cost for his downstroke (which is usually 20% min for rental properties).

Click to expand...

For Cleveland at least, where you have more expensive property (and paradoxically, more competition), prices are 10-12x rents. There's more risk here, and this is a more reasonable relationship. With cheaper property, rents are much higher and there's far less risk. It's a gravy train for landlords.

What I saw in your first graph (credit scores) was a clear example of why the recent real estate crash occurred: An abundance of new homeowners who were not creditworthy for their purchase.

I'm not going to deny that home ownership is becoming more difficult for many Americans, and that trend needs to be reversed. But I see this as symbolic of the growing wage disparity in this country, along with the disappearing middle-class.

I'm not sure what the solution is, but I do not believe it is to give mortgages to those who are poor risks, as was done going into the recent crash.

Click to expand...

I don't believe that this is the solution either. I do think that this current disparity whereby only the rich can get loans needs to end. Either the loans are hard for everyone to get, or they're easy for everyone to get. Making it easy only for the rich means that the rich will dominate and exact massive rents, because no one can stop them.

This chart also gets to the problem. Was there a massive increase in lending to people with low credit scores? Not really.



There was an increase in TOTAL mortgage originations, yes, but this was across the board, not just to those with low credit scores. Note what happens after the crash. Now those with low credit scores are totally excluded from the market. If you have a credit score of 639 or below, you're not getting a mortgage. Why is this a problem? Rent/income ratios have soared, while mortgage affordability (measured by monthly payment/income ratios) has never been lower. Normally, this issue would be self correcting because renters would simply buy a similarly priced property. Today, they don't have that opportunity because of mortgage regulations. Who comes in to benefit? Those who already have high incomes and lots of wealth are buying up these properties for cheap and getting a great return on investment. Because renters can't compete, landlords get to keep their artificially high yields.

Again, there are only two ways out of this. Either we make it more expensive for the rich to get these loans and thereby decrease their effective yield so that property values come down, or we again allow the poor to get mortgages. We're in this strange situation where rents are far higher than monthly mortgage payments. In Cleveland, for instance, this blog post found properties with a monthly mortgage payment of just $285 that rented for $1,000 per month.

Idiosyncratic Whisk: January 2018

I don't think that there's political will to increase lending to borrowers with low credit scores. This means that the only other option is to restrict credit access across the board. Higher real interest rates ought to put a cap on home prices and would actually bring them down. This would also lead to (I assume) a massive contraction. So which is it going to be?

Here is a chart of mortgage rates corrected for rental inflation. The past few years have been great for landlords. When interest rates are below rental inflation rates this is going to drive up borrowing and the cost of housing. It also drives up rents as the real price of housing increases in response. Who bears the cost? Renters, and these poor renters who are paying these rents can't afford to save up for a down payment to buy the homes and the current regulations are working against them. Talk about government working on behalf of the rich!