Written By: Joel Palmer, Op-Ed Writer
A mere 5 percentage points will move 95,000 potential home buyers a year into the category of credit worthy.
That’s based on analysis by The Urban Institute, which released a study earlier this month on the impact of Fannie Mae raising the maximum allowable debt-to-income (DTI) ratio for borrowers from 45 percent to 50 percent. The change takes effect July 29 with the release of a new version of Fannie Mae’s Desktop Underwriter (DU) program.
The non-profit research institution analyzed Fannie Mae loans since 1999 to determine the impact of the increased DTI. Among its findings:
• 95,000 new loans may now be approved annually.
• Of that number, 11,500 Latino and 4,500 black families will benefit from the underwriting change.
• The default probability of mortgages with a DTI ratio between 45 and 50 percent will be only 31 percent riskier than those with a current median DTI ratio of 35 percent, with similar loan characteristics.
• If current expected default costs are approximately 5 basis points per annum, the extra cost on these loans would be approximately 1.5 basis point per annum.
“This expansion of credit comes at a low cost,” states the report.Because the loans will be evaluated by Fannie Mae’s automated Desktop Underwriter program, “these mortgages will have low risk levels.”
The study projects that Fannie Mae will purchase about 85,000 additional loans a year by relaxing the DTI override. This will account for just 3.4 percent of Fannie’s annual purchases and only 0.5 percent of its overall portfolio of 17 million mortgages.
“Further, these loans must still clear all underwriting standards and otherwise receive an approval from Desktop Underwriter. Therefore, the decision to expand credit will not change Fannie Mae’s risk position,” read the report.
John Ligon, a senior policy analyst at The Heritage Foundation’s Center for Data Analysis, disagrees.He wrote that recent history shows that loosening mortgage underwriting standards “made the housing system more fragile and resulted in millions of failed homeownership experiences.”
He also noted that enabling more marginal borrowers to qualify for expensive home loans would lead to increased demand that would “put upward pressure on home prices.”
The Urban Institute had previously reported that tight credit standards since the collapse of the housing market had prevented millions from obtaining mortgages. Its research found that had credit standards been similar to what they were in 2001, about 5.2 million more mortgage loans would been issued between 2009 and 2014.
At the time of that earlier research, the institute said overly tight credit was caused by lender overlays due to repurchase risk, high costs of servicing delinquent loans and fears of litigation.
Richard Green, a professor of public policy at the University of Southern California, wrote last year that DTI isn’t even a strong indicator of the potential for mortgage defaults. He advocated that using regression-based underwriting would“do a better job sorting borrowers more likely to default.”
For its part, Fannie Mae has previously stated they are comfortable with the change from 45 percent to 50. Their research indicated that many borrowers with DTIs in this range have good credit and not prone to default. Many have adequate downpayment and/or reserve funds to offset any risks from having a higher DTI ratio.
Plus, Fannie Mae pointed out that having a DTI of 50 or under doesn’t automatically qualify somebody for a home loan; income, credit scores, and LTV ratios will still be strongly considered.
About the Author
As an NAMU® Opinion Editorial Contributor, Joel Palmer is a freelance writer who spent 10 years as a business and financial reporter and another 10 years in marketing for the insurance and financial services industries. He regularly writes about the mortgage industry, as well as residential and commercial real estate, investments, and retirement income planning. He has also ghostwritten books on starting a business, marketing, and retirement income planning.