The Role of Refi vs. Purchase Lending During the Housing Crisis

MIAMI–The financial crisis that began in 2007-styled as the Great Recession, put housing in the crosshair, with some analysts asserting government policies aimed at increasing first-time home buyers were to blame.

But research from the Urban Institute, Washington, D.C., points to the contrary. UI data show at the height of the boom, mortgage refinances were more likely to default than mortgages taken out to purchase a home, mostly because many people were treating their homes as ATMs through cash-out refinances.

“For GSE 30-year, full documentation loans, defaults were more common and the losses were higher on refinance mortgages than on purchase mortgages,” said Laurie Goodman, director of the Housing Policy Finance Center with the Urban Institute, here at the Mortgage Bankers Association’s Risk Management, QA and Fraud Prevention Forum. “Although there is a lot of blame to go around for the poor quality of loans before the housing crisis, these data reaffirm that purchase borrowers were not the primary culprits.”

Using Fannie Mae and Freddie Mae single-family loan performance data sets, UI research showed delinquency rates for refi loans in 2006 and 2007 were “substantially” higher than purchase loans. Loss severity for purchase loans were also much lower than refis, as were loss rates for purchase loans vs. refi.

“Conventional wisdom suggests that refis should be less risky than purchase loans and default less because the borrowers have a known history of payment,” Goodman said. “So these results are surprising, especially given the stronger credit characteristics of refis, such as lower loan-to-value and debt-to-income ratios.”

In the 2006-2007 cohort, nearly 90 percent of all refinance loans were cash-out refis (compared to less than 50 percent today), Goodman said. “Cash-out refinances dominate when the refi incentive is low,” she said. “During the height of the crisis, the incentive to do a refi was to take out cash.”

During the same period, home price appreciation peaked–and then dropped, resulting in the Great Recession.

Today, Goodman said, with the move toward a purchase market, cash-out refinances are at their highest level since 2006-2007. “The hope is that with new quality control and fraud prevention, the concerns raised in 2006-2007 go away,” she said.

More on the data can be found at https://www.urban.org/urban-wire/using-homes-atms-not-homebuying-fervor-was-more-blame-housing-crisis.