Is credit finally starting to ease up in the mortgage market?

FICO scoresEnlarge GraphEllie Mae is a software provider that aggregates mortgage origination activity

Ellie Mae (ELLI) puts out a monthly Origination Insight Report which provides monthly data and analysis from a sample of closed loan applications that flow through their Encompass 360 Mortgage Management Software. In many ways, it is similar to the way Automatic Data Processing (ADP) reports employment data in that they mine the data they receive from their clients who use their solutions. The Origination Insight report is based off of a relatively robust sample – 44% of all applications that were initiated on their system.  Ellie Mae reports on the characteristics of loans that were approved or denied, along with things like credit scores, loan-to-value (LTV) data, and debt-to-income (DTI) ratios. Ellie Mae estimates that their software is used on 20% of all U.S. mortgage originations.

Is credit beginning to thaw?

Average FICO scores are falling… barely. After plateauing at 750 for most of late Summer/Fall, average FICO scores for approved loans have fallen to 742, which is still a pretty stringent level. During the bubble years, credit was very lax, and average FICO scores were around 720 for 2006, 2006, and 2007.  After the bubble burst, credit became very tight and average FICOs increased to 757.

The Consumer Financial Protection Bureau had hoped that the new Qualified Mortgage (QM) rules would have eased credit conditions somewhat. The QM rule sets standards for new mortgages that codify the “ability to repay” rules. Exotic mortgages, like negative-amortizing (a.k.a. pick a pay) loans, high cost loans, etc are ineligible to be considered qualified mortgages. The CFPB has set a debt-to-income ceiling of 43%. FICO scores are not part of the equation. In return, borrowers are unable to sue a lender if they end up defaulting. Credit is becoming easier to get; however, the question is whether that is due to home price appreciation or due to the QM rule.

Implications for home builders

Home builders, like Lennar (LEN), Meritage (MTH), Ryland (RYL), and KB Homes (KBH), are reliant on a functioning capital market in order to do business. Restricted credit not only hurts them in that some of their potential customers are unable to qualify for a loan, but their customer is a often move-up buyer who needs to sell their starter home. The first time home buyer has been squeezed by a difficult job market and an unforgiving credit market. Add to it the fact that the first time home buyer is lugging a tremendous amount of student loan debt. If they can’t put up 20%, they are more or less stuck with FHA loans in order to buy a house. This predicament for first time home buyers has helped drive the rental boom and the jump in multi-family construction.

As the job market improves, credit scores will get repaired and more people should be eligible for a mortgage. A number of home builders noted that a tight credit market remained a headwind, but that backlog and orders were strong. The West Coast based builders especially noted strength. As credit conditions ease and consumer balance sheets become repaired, home builders can expect increased activity for the next few years.