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Is it Tight Underwriting or Too Few Applicants with Less-Than-Perfect Credit?

Comparing Mortgage Applications and Originations by Credit Score Distribution

Archana Pradhan    |    Housing Trends

In a blog series CoreLogic published last year, we observed that there were far fewer low credit score applicants in 2015 than in 2005.[1] As we enter 2017, it’s time to revisit this topic to see how things have changed in 2016 and compare it this time to 2006.

According to Home Mortgage Disclosure Act (HMDA) data, single-family home-purchase activity has declined significantly compared with a decade ago. There were 10.9 million loan applications for single-family home-purchase mortgages in 2006, which plunged to 3.6 million in 2011 (the lowest in the decade), and rose to 5.2 million in 2015. The decline in the number of applications from 2006 to 2015 represents an overall drop of 53 percent (Figure 1). Similarly, the number of loan originations to purchase a single-family home dropped from 6.7 million in 2006 to 3.7 million in 2015. During this period the denial-rate for home-purchase loan applications dropped from 18 percent in 2006 to 12 percent in 2015. The drop in denial rate could be due to the decline in applications among borrowers with less-than-perfect credit.

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The CoreLogic Housing Credit Index, based on an analysis of six factors, illustrates that loans originated in Q4 2016 have lower credit risk than loans originated during 2001-2002. In other words, loans originated during Q4 2016 are among the highest-quality home loans originated since the Millennium. One of the key factors used in mortgage underwriting as well as in the CoreLogic Housing Credit Index is the credit score. The average borrower credit score for home-purchase originations has increased by about 40 points from roughly 700 in 2006 to almost 740 in 2016 (Figure 2). In 2006, the credit score for the first percentile ranged from 525 to 540 and showed a dramatic rise during the Great Recession and is currently running in a range of 620 to 630. This could reveal that the supply of mortgage originations was constrained as a result of tight underwriting standards. But how has the mortgage demand changed? Could change in demand impact the home-purchase activity?

Originations are the end result of an interplay between loan applicants’ demand and lenders’ risk tolerances. Comparing mortgage applications and originations by credit score distribution helps to disentangle mortgage credit-supply conditions from mortgage demand. Figure 3 shows how the credit score distributions have shifted from 2006 to 2016 for both applications and originations. The share of applications and originations with a less-than-pristine credit score has declined. The difference is more pronounced for applications than for originations. The share of credit scores below 700 for applications has declined and has been offset by a greater share of credit scores above 750. From a credit space perspective, the similarity of the two density distributions for 2016 suggests that lenders were largely meeting the demand of borrowers applying for a loan when compared to 2006. Thus, the observed decline in originations could be the result of potential applicants, particularly borrowers with less-than-perfect credit, being either too cautious or discouraged from applying for a loan, or because of the lack of affordable homes to buy.

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The policy prescriptions are quite different if the decline in originations is attributable to a lack of demand triggered by the perception of tight lending standards, misconceptions (such as ‘home buyers must put 20 percent down’ and ‘must have excellent credit’) and the lack of awareness on low down payment products.[2] For example, more consumer education such as counseling and financial literacy programs could be as or more successful in raising origination levels than introducing new lending products. Targeted marketing campaigns by lenders could also help to dispel the misconceptions and myths, and encourage more applications.

[2] A study conducted by Fannie Mae revealed that only 23 percent of the consumers are aware of 3 percent and 5 percent down payment programs.

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