The Role of ‘Debt to Income’ in Assessing Mortgage Risk


The Washington Post recently ran an article, “Federal government has dramatically expanded exposure to risky mortgages,” which surmised that over the last few years, Fannie Mae and Freddie Mac (the GSEs), and, to an extent, FHA, have taken on too much risky mortgage debt. In particular, the article focuses primarily on debt-to-income (DTI) ratios, and how higher-DTI loans could fare in a financial downturn.

What the article fails to mention is that DTI is only one of the many considerations lenders use when evaluating whether a borrower can and will repay a loan. Lenders also rely on other factors such as credit history, previous housing expenses, cash reserves, equity in the property, and liquid assets to get a fuller picture of a borrower’s true credit profile.

In fact, numerous publicly available studies, and research by the Consumer Financial Protection Bureau (CFPB), have determined that DTI by itself is a weak predictor of a loan’s likelihood of default.

And while the article does discuss the Qualified Mortgage (QM) rule, and how the 43% DTI target was somewhat arbitrarily drawn by the CFPB, it fails to mention many of the rule’s crucial product feature restrictions that have made today’s loans significantly safer than those made in the pre-crisis period.

The QM rule prohibits loans without documented income, with terms of over 30 years, with interest-only or negative amortization features, and that are not underwritten with possible rate increases in mind. These features of both the Dodd-Frank Act and the CFPB rule are far more effective risk-mitigation tools than a standalone DTI cap.

The article also downplays or does not mention the significant protections for taxpayers for loans that do default. Borrowers’ equity in the home securing the mortgage, private mortgage insurance for conventional loans with down payments of less than 20%, and very substantial private capital bearing risk of loss via the GSEs’ credit risk transfer programs meaningfully insulate the taxpayer.

While it is true that recessions are naturally correlated to poor loan performance, this reality argues against the reliance on DTI as a sole or key variable for assessing systemic risk. In a downturn, when the primary wage earner loses his or her job, the DTI at the time the loan was originated is unimportant. As recent studies show, the borrower’s liquid cash reserves are a far more important indicator of risk when unemployment is rising. That is why thoughtful product design and holistic underwriting practices that consider more than a static point-in-time DTI ratio, and good loss-mitigation practices, are the best way to reduce risk and ensure the borrower has a reasonable ability to repay his or her loan.

After the crisis, policymakers created barriers that had the unfortunate effect of preventing many borrowers from obtaining access to mortgage credit. Recent underwriting trends represent a rebalancing, not a return to the pre-crisis risks. In fact, we agree with The Washington Post article’s assessment that housing affordability challenges cannot be addressed solely through more flexible financing.

MBA is deeply concerned about trends that make it more difficult for creditworthy borrowers to find affordable housing. The administration recently released a housing finance reform plan aimed at addressing the future of the GSEs, bringing back private capital, and preserving the important role that FHA plays in the marketplace. Because we share similar goals, we intend to continue to work with the administration, policymakers, and other stakeholders to develop innovative solutions that will protect consumers and encourage lenders to participate fully in all segments of the housing finance market.

Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s