Breaking New Ground in U.S. Mortgage Lending - The U.S. residential mortgage market continues to reinvent itself. While government involvement remains extensive, private asset-backed issuers have doubled their share of the market in just the past two years. Meanwhile, the structure of U.S. mortgage loans has undergone dramatic changes—the consequences of which remain unclear. Despite strong loan performance at present, there are concerns about increased risk taking on the part of lenders and homeowners. Click here for the full FDIC "Summer 2006 - FDIC Outlook" report.
Read on for a summary of the report . .
The mortgage credit cycle has changed dramatically during the past several decades. More than other lending types, mortgage lending practices have been shaped by government influence and product innovation. More recently, rapid home price escalation has constrained housing affordability in many regions of the country, contributing to rising demand for non-traditional mortgages as borrowers try to maximize purchasing power. Mortgage originators have found ways to accommodate borrower demand, offering new mortgage products and extending loans further along the credit spectrum.
These developments in the mortgage cycle have led to increased credit risk held by both homeowners, as they have sought to stretch affordability during an unprecedented housing boom, and by investors seeking yield. The benign credit landscape of recent years may have encouraged increased risk taking.
Based on historical experience, and despite recent strong performance, a gradual rise in delinquency and foreclosure rates could occur over the next few years. Mortgage delinquencies are likely to increase over time as rising interest rates and the expiration of below-market teaser rates result in higher monthly payments for many borrowers. Some households with limited financial assets, lower incomes, or an inability to refinance due to poor credit, lack of appreciation, or high leverage may not be able to accommodate these higher payments. Finally, if a recession or other severe economic shock were to send local home prices and incomes sharply lower, or interest rates sharply higher, this additional stress could contribute to higher mortgage losses.
However, banks and thrifts will head into the next phase of the mortgage credit cycle from a position of strength. In recent years, the industry has generated record earnings and reached near-record capital levels. Given a gradual transition to higher delinquency and foreclosure rates and assuming only modest potential declines in collateral values, it does not appear at this time that deteriorating mortgage credit performance would present unmanageable risks to most FDIC-insured institutions.
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