Three of the Biggest Challenges Facing the Mortgage Industry

The C-Suite

Three of the Biggest Challenges Currently Facing the Mortgage Industry

BY PHIL BRACKEN, VANTAGESCORE

The mortgage industry is at a tipping point. Unalterable institutions and legacy systems that have defined the mortgage finance paradigm for decades are showing their age. As it stands today, millions of consumers can’t attain credit scores, real estate loans are more expensive to produce than ever before, and the United States has a full-fledged single-family home inventory crisis. These facts underscore three major underlying systemic issues facing the mortgage industry that have received little attention relative to their substantial impact. RAPIDLY CHANGING HOMEOWNER DEMOGRAPHICS

The Harvard Joint Center for Housing Policy projects that approximately 75 percent of all new household formation in the United States over the next decade will be by people of color. While the U.S. has far to go with respect to eliminating racial income inequality and socioeconomic disparity, the fact is the American middle class is more diverse than it has ever been. Traditional mortgage credit scoring models, which remain in place and virtually unchanged since the 1990s, are increasingly

inadequate and fail to adequately account for the drastic shifts in credit behavior that are occurring among increasingly diverse millennial borrowers. These credit behaviors, many of which are clear signs of fiscally responsible, credit conscious borrowers, may nonetheless severely penalize or, in many cases, render these consumers entirely unscorable under currently used models. When up to 40 million people do not even qualify for a credit score, something is deeply wrong.

SKYROCKETING MORTGAGE LOAN PRODUCTION COSTS

Just a few years ago, it cost mortgage lenders about $4,500 to produce a home loan. Recently, the Mortgage Bankers Association reported those costs had risen to more than $10,000. These costs, incurred by the lender, are directly passed on to the borrower, acting as yet another deterrent to prospective home buyers and a drag on homeownership growth in the United States. There are many reasons for these exploding costs, but one component for certain is the added labor cost in manually processing mortgage applications for those consumers who are unscorable or underscored using traditional scoring models.

Simply put, lenders are increasingly forced to process mortgage applications manually to account for the rise in applicants who can’t get through the automated portals. Without the ability to incorporate modern credit scoring methods, including the use of trended credit data, traditional scoring models deny millions of prospective borrowers the full benefit of their financial discipline. For example, in many cases, characteristics such as a low credit score, no credit score, or simply the absence of W-2 wages can prevent prospective borrowers from getting through automated underwriting portals, initiating a costly and timeconsuming manual assessment. With scenarios like this playing out on a substantial scale throughout the country, it’s clear that we have structural failures in the mortgage assembly line. However, even if a borrower is approved for a mortgage, it’s becoming harder and harder to find an affordable home to buy. THE SINGLE-FAMILY INVENTORY CRISIS

In many parts of America, there is a severe shortage of affordable single-family homes for owner-occupants. During the most recent 10-year period, the National Association of Home Builders (NAHB) reports that single family new construction is approximately 7 million units short of meeting the normal household demand. After the great recession, the combination of an oversupply of new homes and the wave of foreclosures hitting the market while demand plummeted resulted in home values dropping like no other time in the past 50 years. The Census Bureau reported that at year-end 2010, there were roughly 10 million single family homes sitting vacant in the U.S. Homebuilders were discouraged from building new homes as a result of the oversupply, as well as by tightened government policy and lending guidelines. More than a decade later, many of those tightened restrictions still exist, prohibiting builders from increasing production to meet demand. However, new construction is only half of the equation: Existing houses are not entering the marketplace as frequently because existing homeowners are not selling but are instead refinancing in droves to take advantage of historically low interest rates. Homeowners are staying in their homes longer, 13 years on average, and not releasing inventory for the next generation of homeowners. Combined with rising land, labor, lumber, regulatory, and compliance costs, American homebuilders are facing an uphill battle when it comes to closing the inventory gap. In fact, the NAHB reported recently that the average compliance and regulatory costs to build the average home in America has risen to $84,000 per house. That figure is unaffordable, unacceptable, and unsustainable.

SOLUTIONS

These challenges, while formidable, are not insurmountable. Although much more remains to be done, progress has been made. First, the Fair Housing Finance Authority (FHFA) has recently reconsidered its stance on competition in credit score model development for the mortgage industry. By creating a pathway to allow credit score model developers like VantageScore and others to

bring innovative credit score model development to the mortgage marketplace in a fair and responsible manner, lenders will be able to leverage more representative and predictive information about newly scoreable borrowers and their dynamic credit behaviors. Further, the competition created by this regulatory change will promote innovation in a historically stagnant sector, which should ultimately help to reduce the number of unscorable consumers and, in turn, decrease the volume of costly manual mortgage production.

Fixing the single-family inventory crisis will require a multi-faceted set of solutions that minimize or eliminate overly-burdensome regulations and reduce the costs for new home construction. Helpful proposals would include “fast-tracking” the permitting for affordable homes, promoting manufactured pre-engineered home options, advocating for construction workforce incentives, and many other ideas. One key to implementing these proposals and other ideas is to continue to promote opportunities for builders, lenders, realtors, credit scoring companies, and other real estate industry participants to reach consensus on steps that should be undertaken and to advocate for proposals to be implemented by regulators and policymakers. The Affordable Homeownership Coalition, which VantageScore is a founding member, now includes more than 40 trade groups and other entities that are working together to help solve this crisis.

While homeownership has ever slowly begun to rebound, neither can we indulge in complacency by ignoring the significant structural deficiencies in our mortgage industry nor can we wait for another recession to re-shuffle the deck. The common-sense solutions discussed above are necessary and reflect a universal truth of this industry: The only constant is change. Adaptation has and always will be the strategic imperative. The tsunami of changing consumer demographics requires our industry to continue to work hard, collaborate, and be willing to force meaningful change to meet these homeowners’ needs. We’ll have to battle against several menacing forces to fix these emerging crisis issues because, as we all know, these crisis issues won’t fix themselves. MBM