Lending Standards Are Not Like They Were Leading Up to the Crash

Lending Standards Are Not Like They Were Leading Up to the Crash

If you're concerned about a potential housing market crash, it's important to recognize the significant differences between the current market and the one we witnessed in 2008. One key aspect that sets them apart is the variation in lending standards. Let's examine the data to support this claim.

Every month, the Mortgage Bankers Association (MBA) publishes the Mortgage Credit Availability Index (MCAI), which serves as a standardized quantitative measure focused solely on mortgage credit. The MCAI essentially assesses the ease of obtaining a mortgage. Since 2004, the MBA has been tracking this data, and the graph below illustrates the changes in lending standards over time.

Here's how it works:

• When lending standards are relaxed, obtaining a mortgage becomes easier, resulting in a higher value on the index (represented by the green line in the graph).
• Conversely, when lending standards are stricter, securing a mortgage becomes more challenging, causing the index line to drop.

By examining the graph, we can discern the evolving nature of lending standards, which further supports the argument that the current housing market is distinct from the conditions leading up to the 2008 crisis.

In 2004, the index stood at approximately 400. However, it surged to over 850 by 2006, reflecting relaxed lending standards during that period. In contrast, the present scenario demonstrates a significant shift. Following the housing market crash, lending standards became more stringent, resulting in a decline in the index. Consequently, obtaining a mortgage today has become more challenging compared to the past.

Loose Lending Standards Contributed to the Housing Bubble

Lax lending standards played a significant role in fueling the housing bubble. According to Realtor.com, during the early 2000s, securing a home mortgage was relatively easy. Many individuals were granted mortgages despite providing false information about their incomes and employment, and their financial capacity to afford homeownership was often questionable.

The pronounced peak in the graph above signifies the period leading up to the housing crisis when credit was readily available and loan requirements were far from stringent. Lenders were granting loans without thorough verification processes to determine the borrower's ability to repay. Consequently, more loans were extended to borrowers who carried a higher risk of defaulting on their payments.

Today’s Loans Are Much Tougher To Get than Before

As noted, there have been significant changes in lending standards since the housing crisis. Bankrate describes this transformation by stating that lenders now impose stringent criteria on borrowers, and the majority of those obtaining mortgages possess excellent credit.

Examining the graph, you'll observe a sharp decline in the index line following the peak around the time of the housing crash. Since then, the line has remained considerably lower. In fact, current standards are even stricter than those in 2004, and they continue to tighten further. In May, Joel Kan, the VP and Deputy Chief Economist at MBA, provided an update stating that mortgage credit availability has decreased for the third consecutive month. As a result, the MCAI now sits at its lowest level since January 2013.

The decreasing index signifies the growing stringency of lending standards, clearly indicating a departure from the excessive lending practices that contributed to the crash.

Bottom Line

Prior to the housing crash, lending standards were significantly looser, and there was a lack of thorough evaluation to assess borrowers' repayment capacity. In contrast, today's lending standards are much tighter, minimizing risk for both lenders and borrowers. These distinct differences highlight the fact that the current housing market is fundamentally different from the previous one. It is crucial to recognize that we are not experiencing a repetition of the same circumstances as before.