Mortgage risk set a new series high in July, rising 0.5 points from the same period last year, according to the American Enterprise Institute's (AEI's) National Mortgage Risk Index (NMRI) for July 2018. While the FHA index set a new high at 28 percent, higher cash-out refinances during the period also saw the refinance NMRI rising to an all-time high.
"Higher NMRI indicates agencies continue to increase leverage to maintain levels of mortgage activity and in furtherance of their "affordable housing" mission," said Edward Pinto, Codirector of AEI’s Center on Housing Markets and Finance.
The NMRI monitor's the housing market's stability through real-time tracking of leverage and is a standardized quantitative index for mortgage risks. The index places loans in risk buckets and assesses default risk based on the performance of 2007 vintage loans with similar characteristics, providing a near complete census of government guaranteed loans and purchase mortgage trends.
In July, the data from NMRI indicated a huge spread of default rates across risk buckets with the composite index for purchase loans being led by FHA loans that set a new series high. The AEI said that unless household income accelerated, "future support for the housing market will likely involve further increases in leverage from an already high level."
A massive increase in cash-out risk, which has more than doubled from July 2013, was a key driver for the increase in risks along with a shift towards higher debt-to-income (DTI) after the government-sponsored enterprises (GSEs) increased DTI limit to 50 without compensating factors.
“The increase in the cash-out refinance risk index has been nothing but breathtaking,” said Tobias Peter, senior research analyst at AEI’s Center on Housing Markets and Finance. “With mortgage rates rising over the last two years combined with declining volumes of rate-and-term refinances and flat purchase volume, non-bank lenders continue to ease credit standards for cash-outs, propelled in large measure by steering borrowers to FHA and VA, which have a much wider credit box.”
The data also indicated that subprime loans could be making a comeback. According to the NMRI, while growth in purchase lending volume did not pause equally across the risk spectrum with the volume of subprime loans seeing "a robust increase while prime and near-prime contracted."
Looking at how the general housing trends were impacting mortgage risk, AEI said that the supply-demand imbalance was driving up home prices. "The implications of leverage during a long-lasting seller’s market, now in its 73rd month, are higher house prices concentrated at the lower end of the market and in lower income neighborhoods where leverage has been increasing the most," Pinto said. "On the national level, there has been a long period with few metros experiencing negative home price growth, which is allowing market excesses to build. Moving forward, there will be even more risk as borrowers, especially first-time buyers, are forced to take on more leverage to buy."