Improving credit, not relaxing standards, should be focus for home loans

Zachary Goldfarb reports at the Washington Post that the Obama administration is pushing banks to make loans to those with weaker credit scores, contending that strict standards are leaving many applicants behind financially. If the problem is that many recession-stricken and younger first-time buyers are trying to get loans with poor credit, maybe the first step toward improving matters should be to target the cause: a lousy understanding of credit itself.

As I've discussed before, homeownership is rewarding enough without the incentives the federal government provides (often at the expense of renters). While our promotion of sub-prime mortgage loans was far from the primary cause of the financial collapse of 2007/2008 it definitely made it worse, and many of those who were convinced to take those loans experienced particularly tragic financial hardship. The idea that the Obama administration is so ambitious to revive the housing market that they'd resort to such drastic measures is a disappointment. It should be clear by now that we shouldn't be so reliant upon any one sector for economic growth, whether it be housing, finance, or anything else.

When it comes to credit, most people understand that paying their bills is central to a good score, but beyond that things get shaky. Ultimately the things that matter are to a) have multiple kinds of credit, b) utilize low percentages of your credit limits, and c) pay your bills on time; most everything beyond that is just tweaking for optimization. Despite this, about a quarter of the nation has credit scores under 600 ("poor credit"). There is clearly room for improvement.

Part of this is genuine hardship. Families that go through a serious illness often end up in collections or bankruptcy from medical costs, through no fault of their own--more than half of bankruptcies in the U.S. are due at least in part to medical bills. (Fortunately, the Affordable Care Act will help to reduce this number once it is in full effect.) People lose their jobs and the recession has been especially awful for many of the now long-term unemployed. Things happen, and sometimes no amount of knowledge about the consequences will prevent them from happening anyway.

There are also improvements to the home loan system that can be made, and the Obama administration is right to point them out. A more subjective analysis of individual applicants is completely warranted--someone with a few collections from five years ago (within the reporting time-frame) but consistently on-time payments since then is very likely a safe bet, for example. And Federal Housing Authority loans that allow smaller down payments are also sensible--being required to spend months or years putting away ten or more percent of a mortgage's value before making the purchase is crazy. Money in those amounts is effectively losing value due to inflation and housing appreciation, and once the decision is made to purchase a home it's wasteful to keep spending money on rent rather than investing it in a home.

Low credit scores impact far more than just your chances of approval for (and interest rates on) a mortgage loan, from passed-up rewards on credit cards to higher rates on auto loans to rejections on apartment applications. Rather than focusing on getting more people into homes despite their credit scores, lets first work on nationwide credit education so that people can take advantage of all the benefits of improved credit, not just a government-mandated loophole for home loans. Help people to understand and earn good credit and homeownership will follow, along with a whole host of other broad-based benefits.