How the mortgage industry lies with statistics

By Felix Salmon
June 23, 2011
white paper entitled "Proposed Qualified Residential Mortgage Definition Harms Creditworthy Borrowers While Frustrating Housing Recovery".

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Yesterday something calling itself the Coalition for Sensible Housing policy put out a dense 13-page white paper entitled “Proposed Qualified Residential Mortgage Definition Harms Creditworthy Borrowers While Frustrating Housing Recovery”.

It’s all part of the lobbying campaign surrounding Dodd-Frank, and the eminently sensible idea that if a bank wants to securitize a bunch of mortgages, it has to keep at least 5% of those mortgages for itself. Somehow, in the course of putting Dodd-Frank together, an exception was carved out to that rule, called the Qualified Residential Mortgage, or QRM. For the small group of the most copper-bottomed mortgages, banks could sell off the whole lot, without having to retain 5%.

This gave the mortgage lobby an opening, and they’re attacking it aggressively. They want to open the QRM loophole as wide as possible, and are now kicking up a very loud fuss, complaining that consumers will be damaged if they can’t get access to a QRM loan. The main part of the QRM qualification that they’re upset about is the requirement for a significant downpayment, and so a central part of the lobby’s argument is that if you’re underwriting loans properly, increasing the downpayment doesn’t have much of an impact on delinquency rates. There’s other bits to the argument, too, such as the idea that non-QRM mortgages are going to be much more expensive, but for this post I’m just going to concentrate on the downpayment question.

The white paper explains — in bold type, on page 5 — that “boosting down payments in 5 percent increments has only a negligible impact on default rates”. It continues:

As shown in Table 3 (and in Attachment 2), moving from a 5 percent to a 10 percent down payment requirement on loans that already meet the defined QRM standard reduces the overall default experience by an average of only two- or three-tenths of one percent for each cohort year.

Of course, there are charts and tables. The table comes first:

table.tiff

This is so misleading and confusing that I’ve spent a large chunk of the past 24 hours trying to work out what on earth it’s actually saying, and where the data comes from. The raw data here is indeed being sourced from CoreLogic, and a company called Vertical Capital Solutions did analyze that data, in February 2010. The Vertical Capital report did not, however, have any of the information in this table. Indeed (and inconveniently, from the mortgage lobby’s point of view), it had a whole page which talks about how qualified loans have “substantially higher Delinquencies and Defaults on Qualified Loans with a LTV >80″. (Loan-to-value, or LTV, is the converse of the downpayment: the downpayment and the loan combined are 100% of the loan, since qualified mortgages by definition exclude piggyback loans were second mortgages are involved.)

What the Vertical Capital report does have is a chart of delinquency rates on qualified loans where the LTV is less than 80%, on page 7, and another chart where the LTV is more than 80%, on page 8. Put the two together, and you get something like this:

dlinq.jpg

The difference in delinquency rates between the low-downpayment loans and the high-downpayment loans, here, ranges from 2.94 percentage points for the 2008 vintage, to 7.15 percentage points in 2006. Clearly much bigger differences than are implied in the white paper’s table. And if you look at the percentage increase in delinquency, it’s enormous: all of the delinquency rates more than double, with the lowest increase being 101% in 2006 and the highest being an amazing 502% in 2002.

The mortgage lobby’s own chart, of course, looks very different indeed. Here it is, from page 12 of the white paper:

lobbychart.tiff

What this chart purports to show is that non-qualified loans — the red bars — have very high delinquency rates, while qualified loans — the purple, green, and blue bars — have much lower and pretty similar delinquency rates, regardless of the downpayments they use.

But look more carefully. The non-qualified delinquency rates include all delinquencies for all non-qualified loans. But the qualified delinquency rates are not directly comparable, because all of them specifically exclude qualified mortgages with a downpayment of less than 5%.

I spent some time today talking to the man who put this chart together. (It’s sourced to Vertical Capital, but in fact these numbers came from Genworth’s own analysis of CoreLogic’s data, and Vertical Capital did none of this work.) His name is Anthony Guarino, and he’s the vice president of public policy at Genworth mortgage insurance — the company which initially commissioned the Vertical Capital report. I asked him, if he was showing the delinquency rates for all non-qualified loans, why wouldn’t he show the delinquency rates for all qualified loans? Well, he said, “the consortium didn’t want to even talk about zero downpayment mortgages. Why would we even show that? We’d lose credibility if we showed a qualified loan with no downpayment.”

Guarino was perfectly happy to tell me that by excluding all the loans with downpayments of less than 5%, “you’re throwing out the loans with the higher default rates. No one’s saying that downpayment doesn’t matter.” But compare that with the official tone of the white paper:

Based on data from CoreLogic Inc., nearly 25 million current homeowners would be denied access to a lower rate QRM to refinance their home because they do not currently have 25 percent equity in their homes… Even with a 5 percent minimum equity standard, almost 14 million existing homeowners – many undoubtedly with solid credit records – will be unable to obtain a QRM. In short, the proposed rule moves creditworthy, responsible homeowners into the higher cost non-QRM market.

This sounds very much as though even a 5% minimum downpayment is desperately unfair to millions of American homeowners; there’s no indication whatsoever, in the paper, that including a minimum downpayment of 5% in the definition of what constitutes a qualified mortgage might actually be a good idea. Yet when the consortium wants to publish a chart showing the delinquency rates of qualified mortgages, it’s very careful to first strip out any mortgages with a downpayment of less than 5%.

On top of that, the bars in the official chart all look very similar largely because they are very similar: the industry is essentially comparing a set of loans with itself, and declaring that there’s not a lot of difference. The purple bar is all the loans with a downpayment of more than 5%; the green bar is all the loans with a downpayment of more than 10%; and the blue bar is all the loans with a downpayment of more than 20%. The blue bar is a subset of the green bar, which in turn is a subset of the purple bar. The chart is designed, in other words, to look at similarities rather then differences.

I asked Guarino if he could send me the data sliced more naturally: how do loans with a downpayment of less than 5%, for instance, compare to loans with a downpayment of between 5% and 10%? To his credit, he did come back to me with some new data, even if it wasn’t exactly what I asked for: he refused to slice the loan tranches by year, as he did in this graph. Instead, he would only give me aggregate figures, for 2002-2008 and for 2002-2004. Here’s what they look like, charted:

dlinqq.png

When the mortgage industry starts complaining about the 14 million people who would be denied the chance to buy a qualified mortgage if they don’t have a 5% downpayment, it’s worth remembering that qualified mortgages for people who don’t have a 5% downpayment have a delinquency rate of 16% over the course of the whole housing cycle. (You can be sure the numbers were much higher still in 2006 and 2007, which is why Guarino didn’t give them to me.)

And you can see too why the 20% downpayment limit was put in place: it’s the point at which delinquencies fall to less than 5%. If you take one group of loans with a 20-25% downpayment, and a second group of loans with a 15-20% downpayment, then the second group, on these numbers will have a delinquency rate 56% higher than the first.

The big picture here is that QRM is a distraction, which really shouldn’t exist in the first place. But given that it does exist, the downpayment requirements embedded within it are perfectly sensible. The lower the downpayment, the more likely a loan is to become delinquent. By far. That’s a simple fact which the mortgage lobby will go to astonishing lengths to hide.

Update: Guarino responds in the comments.

Comments
31 comments so far

The other lie, Felix, is that a requirement of higher downpayments will make houses unaffordable for the middle class. (Senator John Kerry stands firmly behind this nonsense.)

Yet as best I can tell, if banks were to insist on a 20% downpayment you would end up with much lower sale prices. If you don’t allow people to borrow as much, then they can’t spend as much. If people can’t spend as much, then prices fall. Right?

Senator Kerry (and the other Democrats owned by the banking industry) don’t care that housing is grossly overpriced and a strain on the budgets of middle-class America. They only care about padding the books of their banking friends. To hear them talk, you are wealthier if you need to borrow (and make payments on) $400k to buy a house than if you purchase the same house for $300k.

Posted by TFF | Report as abusive

Are mortgages with LTVs of 70%-ish really at 4.2% delinquency rates over this time period? That would be a lot of prime mortgages… I would’ve thought those ‘safe mortgages’ were much lower… wow. If that’s true, then the true interest rates for a mortgage through the cycle should be much higher, and the number of borrowers getting mortgages far fewer

Posted by FDum | Report as abusive

Great work Felix.

Posted by dedalus | Report as abusive

well researched, Felix, and nice job recognizing the subset fallacy.

Posted by KidDynamite | Report as abusive

Seconded, dedalus

Posted by ottorock | Report as abusive

One of your best Felix.

Posted by agentgreg | Report as abusive

Thanks for this. Absolutely terrific analysis.

Posted by jomiku | Report as abusive

Thank you, thank you, thank you. A great bit of analysis. Tanta would have given you props for this one.

Posted by TomLindmark | Report as abusive

Darrell Huff would be proud.

One important issue in a culture in which people know/care more about American Idol than the details of policy that affects their pocketbook: How to disseminate your findings to a wider audience.

Posted by aquacalc | Report as abusive

Nice post.

Posted by Greycap | Report as abusive

Not quite on TFF’s point, but close, is that some of the safer borrowers who choose lower downpayments when the cost is relatively low will save up to put more of their own skin in the game if the cost of a small downpayment increases. Put this in place, and ten years from now you will have a stronger separating equilibrium, i.e. the low downpayment groups are likely (conditional on the economy and housing market) to be worse; if the QRM is supposed to select out the best risks, it will do so to a greater extent than is indicated by numbers drawn from a regulatory regime that doesn’t give them preference.

Posted by dWj | Report as abusive

Excellent job, Felix. Just one question. I don’t understand why banks would not want to keep the “skin in the game” on the very best quality loans, rather than slough it off onto Fan/Fred. Am I missing something? If you have to keep the 5% from riskier loans, wouldn’t you also want to keep the best on your books?

Posted by LadyGodiva | Report as abusive

dWj, that is an excellent point.

When we bought at $295k, our loan was written to the maximum conforming amount of $252,700. (We avoided PMI by writing a lien against one of our investment accounts.) Had this option not been available, we would have made the larger downpayment — but that would have left us with a smaller emergency fund than we preferred.

It doesn’t typically pay to borrow more when you could make a larger downpayment, but it leaves you with greater flexibility and security. We didn’t want to fall into a cash trap.

Posted by TFF | Report as abusive

Anything the mortgage industry says is a lie, including “and” and “the”
as well as “1″ “2″ “3″ “4″ “5″ “6″ “7″ “8″ “9″ and “0″

Posted by fresnodan | Report as abusive

in the proposed regulation, they cited a paper in the journal of housing research that shows that zero down mortgages were much worse than otherwise comparable loans with as little as 3% down.

“Skin in the Game: Zero Down Mortgage Default”

http://papers.ssrn.com/sol3/papers.cfm?a bstract_id=1330132

Posted by mort_fin | Report as abusive

Thank you for doing the hard leg work, Mr. Salmon. I hate to admit it, but even with my advanced degree in earth sciences I found my eyes glazing over after the second chart.

So, if I get the gist of this article right, the mortgage industry is desperately trying to return to the halcyon days of unrestricted mortgage lending that preceded the calamity of 2007-2008. Is this a correct assumption? I realize they would strenuously deny that take on this data, but you have to forgive me for being so cynical. My faith in the corporate world is not what it once was.

Posted by IntoTheTardis | Report as abusive

Four arguments in favor of a 20% downpayment

(1) High-LTV loans are provably more likely to end up in default. Felix’ charts demonstrate a 2002-2008 default rate of 4%-5% on loans with a 70%-80% LTV and a default rate of 7.5%-9.5% on loans with an 80%-95% LTV. That is a substantial difference! When people begin with a larger downpayment, they are less likely to end up underwater (and if they are underwater it will be by a much smaller amount). Underwater loans are by far the most likely to default. Why stretch to pay more for a house than it is worth?

(2) Twenty years of booming real estate has left us with a housing market that is unaffordable for your average American household. Rent/income ratios are sky high, making it hard for young families to save a downpayment. Price/income ratios are even higher, making it difficult for homeowners to keep up even after they purchase. Middle-class incomes are not going to increase any time soon, so the only way to repair this imbalance is to bring down the cost of housing. Reducing demand, by tightening underwriting standards, is one of the most effective mechanisms for making housing affordable again.

(3) One reason why dividend stocks are less risky is that the income stream offers a “floor” for the value of the company. If you have a stable company that pays a dividend that matches the yield on the 10-year Treasury, you aren’t depending on growth to justify the investment. Stability is sufficient. For real estate, a “floor” for housing occurs at the price where it makes sense for investors to step in as landlords. Investment properties typically require a 25% downpayment. If you allow owner-occupied mortgages with a much lower downpayment, you increase the spread between the market and this natural floor. That results in a more volatile market.

(4) The typical argument in favor of a lower downpayment is, “It takes years, even decades, for your typical household to save a 20% downpayment.” This hearkens back to my second point — housing prices and rents are presently unaffordable and NEED to fall much further to relieve the strain on household incomes. Yet consider the other implication of this statement. Household budgets are seriously stretched, even while renting. And for various reasons, the cash flow cost for ownership is typically greater than for renting! (Especially true at the Price/Rent ratios we’re seeing in many markets today.) If you can’t save rapidly while renting, you won’t be able to keep up with the cost of ownership. Only if incomes increase rapidly (thus repairing that deficit within a few years) does this unfortunate truth break down.

So go ahead and boost those required downpayments! Force renters to learn how to save 10% of their income (enough for a 20% downpayment after six years, assuming a 3x Price/Income ratio). Put some downward pressure on the housing market so that a 3x Price/Income ratio is realistic, rather than the 4x or 5x that we’re seeing in many markets today. Reduce market volatility (by making it more attractive to deep-pocket investors) and by increasing the “skin” that people have in the game.

We’ve seen what the philosophy of “buy now, pay later” does to real estate. Perhaps it is time to adopt a more patient approach?

Posted by TFF | Report as abusive

I must have read this article around 25 or so times now trying to wrap my head around the numbers. I was initially going to respond with criticism about comparison between the first two charts but after another 15 or so reads, it clicked and you’re right. How can anyone jive the first table with the last chart? That chart seems to imply that a change from 5% to 20% would have had ~50% reduction in delinquencies.

Posted by spectre855 | Report as abusive

Very timely article for me. I’m currenty selling a condo in a safe, beautiful suburban neighborhood. It took 15 mos to find a buyer. A professional with a Master’s Degree that works as an analyst at a major bank. She exceeds all the credit and financial requirements. However, incredibly, after the loan officer set two tenative closing dates the bank she works for rejected the loan. Why? Because the condo association just finished up a successful law suit against a unit owner for non-payment of fees. The bank stated that the law suit would make the loan unsalable on the secondary market. Thankfully she has not given up and is trying again (paying for a second appraisal) with another mortgage institution. That is hitting snags also that have nothing to do with her or I. I think ultimately we’ll work around them but this process has taken almost 3 mos and hundereds of dollars. And this is between willing and qualified buyer and seller. Mortgage banking has quite literally gone insane.

Posted by GLK | Report as abusive

Felix,

The answer to the entire Mortgage industry question is really fairly simple. Get all of the brilliant Mortgage executives from the GMAC/RFC, Wells Fargo Mortgage, BOA/Countrywide, JPM/Washington Mutual, Mortgage General Insurance Corp, Fannie and Freddie, throw in a few from the Rating agencies, and investment banks – Goldman Sachs and Morgan Stanley, maybe some AIG alumni, then throw them all in an offsite for 2-3 weeks. Whatever they come up with, just do the exact opposite.

Posted by Thucydides | Report as abusive

That last chart is the real kicker for whether or not this real estate market really goes into a complete tail spin. Currently ~ 28% of residential properties mortaged are under water. Unfortunately that also implies a rather large “flank” number somewhere between 80% LTV and 100% LTV. The last chart demonstrates exactly why, historically speaking, these deteriorating home values and associated current LTV’s are potentially the biggest grenade on the landscape. And someone wants to argue about the size of down payments in the midst of a falling knife?

Posted by Thucydides | Report as abusive

Perhaps that is where these proposals are coming from, Thucydides?

The banks realize that real estate is STILL overpriced, and that another drop of 20% (or more) would truly hammer their books. They are willing to do or say anything to prop up the market — including a continuation of risky lending practices.

Posted by TFF | Report as abusive

very easy to say increase the DP to 20%, but in most markets (in a good neighborhood with good schools, etc) close to the left and right coasts that means a DP of at least $60,000. For the average american in those markets, that’s just not feasible as alot of them have burned through some of their nest egg over the past few years due to unemployment. $60k for them might take 5 years for them to buy. I can see a change from the FHA 3.5% to say 10%, but 20% is a HUGE difference and if passed get ready for another big decline in home prices.

Posted by rjfisher | Report as abusive

If the purpose of Federal guarantees on mortgages is to make housing more affordable for more people, why not require the sales price to be under the median sales price for the past 12 months? Why subsidize the upper half of the income spectrum? They do not need it.

Posted by txgadfly | Report as abusive

The numbers don’t mean anything. Since the banks abused the system with bad loans. They intentionally went after the unqualified to an extreme degree, for profit, and then crashed the market. The charts show how giving bad mortgages continued to escalate.

A return to qualifying standards before the run on bad loans and high profits, is the simple solution.

1 or 3 percent down is still a great way to get people into homes, if they qualify with minimum incomes like before. To even suggest people take huge hits on their only major investment of their lives is lunacy.

Posted by vforv | Report as abusive

“To even suggest people take huge hits on their only major investment of their lives is lunacy.”

Is it better, then, to support prices at a level that bankrupt us all? Young, old, renters, homeowners alike?

One way or another, you pay for the cost of what you live in. A rise in real estate values has minimal impact on those who already own, but it makes housing much more expensive for those who do NOT already own. Turn this around, and a decline in real estate values could be a net positive — if it happens slowly enough to avoid triggering another wave of defaults.

Posted by TFF | Report as abusive

I firmly believe that a higher down payment is needed when Home prices are inflated and speculative. But I also believe that when the Home prices are normal (as they are at this time), affordability and a borrowers credit history should be a deciding factor rather than a down payment. The percentage of down payment should be used purely as a tool to control speculation rather than as a tool to control the banking system.

Posted by NeilK | Report as abusive

Beautiful work Mr. Salmon–your stats professor would be proud. Now let’s see if we can get this out there to the “right” people.

Posted by kisno | Report as abusive

Felix accuses the Coalition for Sensible Housing Policy of making arguments it’s not, in fact, making. We are not saying that low down payment loans aren’t riskier than higher down payment loans. Industry statistics – including the data in Mr. Salmon’s blog post – show that the greater the down payment, the less likely a loan ends up in default.

What the chart in the white paper shows is that low down payment loans that follow strong underwriting and product standards (e.g., no negative amortization, no interest-only features, protection from sharp payment increases, full documentation of income and assets, etc.) can be exempted from risk retention without exposing investors or the broader housing market to undue risk.

The red bar in the chart in our white paper shows the performance of mortgages originated from 2002-2008 that DO NOT meet ALL of the standards and features outlined in the note in the original chart. The other bars show the performance of mortgages that meet ALL of these product and underwriting features.

Within this second group of bars, the blue bar shows how loans performed that met all these standards, plus had a 20 percent down payment or more; the green bar shows loans that met all the standards plus had a down payment of at least 10 percent; and the purple bar shows those loans with at least a five percent down payment. Naturally, loans with strong standards AND at least 20 percent down performed best. But – and here’s the bottom line – the chart also shows that including loans with lower down payments BUT WITH STRONG STANDARDS in a QRM definition won’t create excessive risk.

Our point, – and this is a policy judgment with which Mr. Salmon may disagree – is that requiring a 10 or 20 percent down payment IN ADDITION TO strong underwriting raises the cost and reduces the availability of mortgages for otherwise creditworthy families, but does so with only minor improvements in overall default rates. The Coalition believes this is an unnecessary trade-off that would have a disproportionate impact on moderate income and minority families and would undermine efforts to create a sustainable housing recovery.

Posted by AnthonyGuarino | Report as abusive

Absolutely great article. I read a lot of blogs and statistics and this took me a while to wrap my head around exactly what you were saying because of how absurd the lobbyist’s delivery is. I am very impressed by the fact that you caught the subset structure in the graph. WHAT A JOKE!!! Thank you very much.

I will be mentioning this article in my blog…

http://www.thecashflowisking.com

Posted by huntert | Report as abusive

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Posted by Andy124 | Report as abusive
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