New Mortgage Lending Standards: A Dangerous Overreaction?

Could the housing market be getting too cautious?

Critics say the tough new underwriting standards that were imposed to prop up the sagging subprime mortgage market are harming some creditworthy borrowers by trapping them in high-cost loans.

Reacting to a nationwide spike in subprime loan defaults, lenders recently raised their requirements for bad credit home loans to borrowers with low credit scores. But some analysts say the industry is overreacting.

“I see it as definitely a bad thing,” said Greg Wickstrand of GMAC Mortgage Corp. in San Diego.

Subprime borrowers whose adjustable loans are about to reset at higher mortgage rates now have “dramatically fewer opportunities to lock in a longer-term fixed rate, giving them more stable payments,” he said.

The collapse of the subprime market “is something that was waiting to happen, with investors buying any loan originated, regardless of the risk,” Wickstrand said. “You have got people who are good citizens, worthy borrowers, who are being caught in the pinch. They now have a loan they can’t afford the payments on and they are not being offered reasonable options” to mortgage refinance.

Nicolas Retsinas, director of Harvard University’s Joint Center for Housing Studies agrees there is a risk of overcorrection as investors and lenders rush to bring more stability to the subprime market.

“The danger is that we might turn the clock back and curtail credit to borrowers perceived as credit-impaired,” he said. “ . . . The challenge is to develop products that appropriately price and disclose risk, while reaching out to the underserved.”

At the Springboard consumer credit counseling service, President Dianne Wilkman says new lending practices will keep homeownership beyond the reach of many middle-wage earners in the Southern California housing market. “Tighter underwriting standards are going to keep a lot of people locked out.”

In contrast, economist Zoltan Poszar of Moody’s Economy.com says raising the bar for borrowers was necessary. Lenders were taking too many risks, he holds.

“Subprime borrowing has been tightened significantly,” he said. “It is a market that is getting healthier and healthier. If you have a decent credit score, you are a breath of fresh air to the lenders.”

Kevin Stein, associate director of the California Reinvestment Coalition, a lending watchdog group based in San Francisco, says many consumers with credit problems were sold loans that were “almost designed to fail.” As underwriting standards are tightened, lenders also should address the needs of those who were steered into mortgages they couldn’t afford, he stressed.

Risky adjustable-rate mortgages (ARMs) that offer low monthly payments before adjusting upward have been used improperly to keep consumers in the marketplace, Stein said.

“The trend has been to make loans that satisfy the needs for Wall Street and now it is all coming crashing down, but the ultimate loser is the borrower who can’t make their payments,” he said.

“San Diego is right in the heart of all of this. There have been a lot of questionable loans sold in San Diego, a lot of nontraditional option-ARM, interest-only loans. We have a whole lot of loans that have been made where people didn’t understand and couldn’t afford their payments. To me, that is an indictment of the industry.”

San Diego County homeowners are defaulting on loans at a rising pace.

In the first two months of this year there were four times as many default notices issued as were issued during the same period of 2006. Foreclosures here tripled over that period, according to DataQuick Information Systems. Even so, California mortgage defaults still represent a small fraction of the market. DataQuick analyst John Karevoll says there is no cause for alarm.

Poszar warns that the number of loan defaults here and around the country has the potential to continue rising, however.

Adjustable loans with low-interest teaser rates “are resetting and people can’t pay the fully indexed rates,” Poszar said. “The worst quality is 2005 and 2006 loans. The loans resetting now are loans made in 2004. The worst is yet to come.”

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