Cutbacks in high debt ratio loans could hurt home buyers

A key policy change by mortgage giant Fannie Mae that offered homeownership to thousands of new buyers — many of them minorities — could face significant cutbacks. The reason: Private mortgage insurers are re-thinking their decisions to participate.

The change, which took effect last July, allowed borrowers with debt-to-income (DTI) ratios as high as 50 percent to obtain low down payment mortgages. Homeownership advocates generally welcomed the move, arguing that it could open the marketplace to credit-worthy families who simply carry high debt loads. A study by the Urban Institute predicted it could stimulate 95,000 new home purchases a year nationwide, especially among Latinos and African-Americans, who have higher DTIs on average than other buyers.

Debt-to-income is a crucial factor in mortgage underwriting and is one of the biggest reasons for application rejections. It measures borrowers’ recurring monthly debts — credit card bills, auto loan payments, rent, etc. — against their gross monthly income. As a general rule, the lower your DTI, the better your chances at being approved for a loan. If your DTI is exceptionally high, with credit payments eating a hefty chunk of your income, you’re considered more likely to encounter financial strains and miss mortgage payments.

The federal government’s maximum DTI for a “qualified mortgage” is 43 percent. Fannie Mae, the single largest source of mortgage money in the U.S., has in recent years stretched that limit to 45 percent and sometimes beyond when borrowers had compensating factors in their applications, such as a high credit score or substantial cash reserves. In its push to raise the ceiling to 50 percent DTI, Fannie noted that all the loans would have to pass the standard tests of its automated underwriting system, which are designed to flag or reject excessive credit risks.

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In the intervening months, the relaxed DTI requirement attracted increasing numbers of new buyers. Fannie Mae won’t say how many precisely, but in its most recent quarterly securities filing it acknowledged that it had grown to 20 percent of new purchase loan acquisitions. In all of 2016, by comparison, the proportion had been just 5 percent. But as the numbers rose, concerns began to mount among some of the private mortgage insurance companies who play an essential role in all of Fannie Mae’s low down payment mortgage programs. On loans where borrowers put less than 20 percent down, these companies insure against defaults — essentially taking a portion of the risk of loss from default in exchange for premium payments from the borrower.

Several major insurers say they began detecting an ominous trend last fall: Too many of the applicants being approved presented multiple risks, including credit scores indicating previous payment problems, low or no financial reserves to fall back on in the event of a budget squeeze, plus low down payments. Mike Zimmerman, a spokesman for one major insurer, MGIC, told me in an interview that past experience has shown that “layering” of multiple risks like these produced 30 percent to 50 percent higher rates of default, opening the door to unacceptably high future losses for the company and potential financial disasters for borrowers.

“We’ve seen this movie before,” he said, “so we don’t think it’s right.” MGIC stopped insuring mortgages with debt ratios above 45 percent March 1, unless they come with FICO credit scores of 700 or higher. Essent Guaranty announced a similar policy effective March 12. Genworth Mortgage Insurance says it plans to do the same starting March 19. Radian Guaranty Inc., another big player, is taking a slightly different approach, banning certain high DTI loans where the down payment is less than 5 percent. Radian said in a statement that it will “continue to monitor these applications and assess any need for further changes.”

For its part, Fannie Mae acknowledged the problem in its most recent quarterly securities filing and said it plans to revise its automated underwriting system’s treatment of high DTI loan applications that carry multiple layers of risk. As a result of the revisions, Fannie said, it expects to approve fewer high DTI mortgages with multiple risk factors than in recent months.

Some lenders say the reductions could frustrate home purchase opportunities this spring for families across the country. “If they (the insurers) are going to have 700-plus (FICO) scores as the driving force,” said Joe Petrowsky of RightTrac Financial Group, “that will affect a lot of prospective buyers. Minorities will get hurt for sure.”

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