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What is Driving Risk Higher on First-Time Buyer Loans?

Up and Down Graph BHWith a greater share of agency first-time buyer home loans comes a greater share of risk involved in those loans.

The share of Agency first-time buyer loans surged by 18 percent in April up to 58.8 percent, meaning that 58.8 percent of primary owner-occupied home purchase mortgages with a government guarantee in April were first-time buyers, according to AEI’s International Center on Housing Risk. Meanwhile, the Agency First-Time Buyer Mortgage Risk Index (FBMRI) shot up to 15.8 percent in April, a series high and an increase of 0.6 percentage points over-the-year.

An Agency FBMRI value of 15.8 percent means that 15.8 percent of these loans would default under economic stress similar to what the country experienced in 2007-08, based on performance of loans originated in 2007.

The gap is widening between risk on first-time buyer loans and loans for repeat buyers, according to AEI. The Agency FBMRI was 5.6 percentage points higher than the risk index for repeat buyers in April 2016, which was an increase from 5.4 percent from the previous April.

Also according to AEI, 54.2 percent of first-time buyer loans were high risk in April 2016—an increase from 52.6 percent a year earlier.

5-23 AEI graph“The gap between first-time buyer and repeat buyer mortgage risk levels now stands at 5.6 percentage points compared to 5.4 and 4.7 percentage points in April 2015 and 2014 respectively,” said Edward Pinto, codirector of the AEI’s International Center on Housing Risk. “The long running seller’s market combined with growing loan leverage and weak income growth for entry-level buyers are artificially pushing up prices, resulting in a pernicious wealth transfer from the buyers to sellers of these homes.”

According to AEI, “First-time buyers have accounted for the bulk of the year-over-year rise in the composite National Mortgage Risk Index for home purchase loans since early 2015, reflecting the widening gap between the risk indices for first-time buyers and repeat buyers compared with a year earlier.”

Risk layering is largely responsible for the increased riskiness of the first-time buyer mortgages. According to the report, 70 percent of first-time buyer mortgages in April 2016 had a combined loan-to-value (CLTV) ratio of 95 percent or higher and 97 percent had a 30-year term. The combination of slow amortization and little money down will likely result in very little home equity for these buyers for many years, barring substantial home price appreciation.

In addition, slightly more than one-fifth of first-time buyer loans in April had a FICO score of below 660, which is the traditional definition of subprime mortgages, and nearly 30 percent of them had total debt-to-income ratios higher than 43 percent—the limit set by the Qualified Mortgage rule.

According to AEI, two factors that made repeat buyer mortgage less risky were: a much smaller share of repeat buyer mortgages had a CLTV of 95 percent or higher and a much smaller share had a FICO score below 660.

About Author: Brian Honea

Brian Honea's writing and editing career spans nearly two decades across many forms of media. He served as sports editor for two suburban newspaper chains in the DFW area and has freelanced for such publications as the Yahoo! Contributor Network, Dallas Home Improvement magazine, and the Dallas Morning News. He has written four non-fiction sports books, the latest of which, The Life of Coach Chuck Curtis, was published by the TCU Press in December 2014. A lifelong Texan, Brian received his master's degree from Amberton University in Garland.
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