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Mortgage Risk Down Slightly; Remains Nearly Double Sustainable Levels

Mortgage risk as measured by the American Enterprise Institute’s (AEI) International Center on Housing Risk fell slightly from January to February, though certain market segments continue to see a rise in potential problem loans.

AEI’s National Mortgage Risk Index (NMRI), a measure of loans’ default risk under stressful conditions, retreated to 11.6 percent last month from January’s reading of 11.8 percent. To gauge where February’s index lies historically, 1990 vintage loans would have an estimated index value of 6 percent, while riskier 2007 loans would be up at 19 percent.

Both of the component indices measuring risk ticked up, indicating an increase in default risk; the index gauging risk conditions at Fannie Mae and Freddie Mac inched up one-tenth of a percentage point to 5.9 percent, while the Federal Housing Administration’s (FHA) risk index moved up the same amount to 24.5 percent.

An index value of less than 6 is “indicative of conditions conducive to a stable market,” AEI says.

While both components were up, the overall composite still benefited from a decline in the share of high-risk loans last month and a slight improvement in the share of low-risk loans. Still, at 42.8 percent, low-risk lending remained down more than 4 percentage points compared to six months prior.

Even with the overall decline, February’s index illustrates the lack of impact the qualified mortgage (QM) rule has had on lending, AEI says—due in part to selective enforcement of the 43 percent debt-to-income ratio (DTI) requirement. According to the group, about a quarter of home purchase loans tracked in the index that are classified as QM exceed that threshold.

“Since all of the government agencies are exempt from that, we see a continuing rise in loans with debt ratios above 43 percent,” said Edward Pinto, resident fellow for AEI and co-director of the International Center on Housing Risk.

At the local level, all states registered index values above the 6 percent line, with only Hawaii coming in below 7 percent. Most states have a composite index between 9.5 and 13 percent, AEI reports, though a few at the high end of the spectrum—such as Mississippi—remain in the mid-teens.

“Most of this variation is really a result of whether a state has a high or a low concentration of FHA loans,” said Stephen Oliner, resident scholar for AEI and also co-director of the Center on Housing Risk. Oliner offers as an example California and Texas, the two states with the largest FHA markets and which each have risk indices above 10 percent.

“It’s clear the FHA is not doing any active risk management with regards to the loans that they’re guaranteeing” in vulnerable states, he added.

Monday’s release from AEI is timely as more lenders discuss their options to expand offerings and guidelines for borrowers with credit scores below 640—loans that, according to AEI scholars, have a greater than one in three chance of defaulting.

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