New York Fed: rejection of mortgage lending distorts credit rating

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The pandemic is waning, and the US economy – clumsily, of course – is reviving.

This means that abstinence programs must be discontinued. During the pandemic, lenders offered these programs to borrowers to ease the burden of payments on credit cards, student loans, and mortgages in the face of job loss, illness, and economic disruption.

In an interview with Karen Webster, economists from Liberty Street Economics – blog Federal Reserve Bank of New York – said that the mortgage industry could have a hand in distorting credit ratings. And now, more than ever, it is important to have a holistic view of the consumer / borrower.

Among the respondents Andrew F. HowoutSenior Vice President, Research and Statistics Group, Federal Reserve Bank of New York; Donghun Lee, employee of the research and statistical group of the bank; Joel Scully Senior Data Strategy Specialist in the Bank’s Research and Statistics Group; as well as Wilbert van der Klauw, senior vice president of the research and statistics group of the bank.

The report titled “What happens when a mortgage is canceled?“. In their research, officers found that since March 2020, more than 6.1 million mortgage borrowers have entered patience… These condescending participants were “much more prone” to committing delinquency before the pandemic than was observed among the general population of mortgage holders. About 8 percent of borrowers were late in payments before enrolling in abstinence programs. About a third of previously overdue invoices were still on hold.

This raises the question of the impact of credit ratings and whether we need a new credit rating system.

At a high level, Scully said the tolerance program was “very successful in that it protected consumer credit reports from widespread damage and allowed people to stay on top of their loans.”

Risk signals to lenders

But therein lies what at first glance seems like a mystery. The data shows that about 4 percent of mortgage borrowers may find themselves in serious arrears – certainly less than they were during the Great Recession, but still worrying since their status has not yet impacted credit reports. Thus, lenders may not yet see the risk signals inherent in these borrowers because leniency is credit-neutral and can lend money where they should not.

But, as Scully noted, many mortgage borrowers, while not having to pay for their property, have been able to accumulate funds (stimulus payments have helped) and reduce other debts in the process. So, all other things being equal, they should be able to take on the payout when they get out of tolerance.

There is a tailwind of credit rating growth due to non-mortgage debt. Lee noted that the rise in the credit rating seen amid the pandemic came mainly as federal student loan the debt (approximately 85 to 90 percent of the total outstanding debt) was withdrawn from consideration.

But there are enough signals that lenders will be able to see the risks quite clearly after the pandemic.

The friction stems from the fact that at least some borrowers before the pandemic already had at least one account collection, and as Lee said, “If you have 10 negative records and one record disappears, there will be nine negative records. … records. “

Possible way out

When it comes to a possible way out of leniency in the mortgage industry, we will see two traces of activity.

At least some of these borrowers exit the program by selling their properties, thereby eliminating these borrowings altogether. Lee noted that lenders have worked with borrowers in a lenient manner to structure the outlets that make debt that is still in accounting more manageable. In many cases, Lee said missed payments are “added” at the end of the mortgage, so in general a 15-year term will be 16 years.

“Don’t expect refinancing to bounce back,” van der Klauw cautioned. It is unlikely that people who struggled to make their mortgage payments before the pandemic will suddenly qualify for refinancing due to their credit ratings gradually increasing as a result of tolerance.

“We really haven’t seen evidence of an increase in applications just because people’s credit ratings are going up. They may not even know that their credit rating has improved slightly, ”said van der Klauw.

Haughwout added, at least this time around, the traditional FICO rating may not reflect – at least not very well – what happens during a pandemic as this is not a typical recession.

As he told Webster of those who participated in the Abstinence program and FICO scores, “Does this have a lot of information about their future ability to pay off debt? I’m not sure if this is the case. “

Credit ratings are evolving and may be adjusted (using new algorithms) to reflect time (as well as widely reported, banks are lowering credit rating requirements for some loans). After all, the old 620 is not the new 620.

As for what lies ahead: more data will help lenders make better decisions. According to Howewauth, research shows that investors in the housing market at the turn of the millennium had high credit ratings – as they deferred and repaid many mortgages. But they were, of course, burned down as a result of the collapse of their homes (and they had no incentive to pay because they did not live in houses with their families).

“It’s important for a lender to look at the entire credit report, not just the credit rating,” he told Webster.

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