Some of the nation’s largest mortgage lenders and housing trade groups may support the Consumer Financial Protection Bureau’s plan to eliminate the debt-to-income ratio requirement of the Qualified Mortgage rule, but one of the top credit rating agencies claims the change would be dangerous for borrowers.
In a note sent out Wednesday, Fitch Ratings stated that moving away from using DTI in the mortgage underwriting process would “weaken” borrower protections from “aggressive lending practices.”
The Ability to Repay/Qualified Mortgage rule was enacted by the CFPB after the financial crisis and requires lenders to verify a borrower’s ability to repay the mortgage before lending them money.
This includes a review of a borrower’s debts and assets to ensure they have the ability to repay the loan, with a stipulation that their DTI ratio does not exceed 43%.
But the CFPB proposal, which is not yet official, would replace the DTI threshold with a different mechanism.
One alternative floated by the CFPB is moving to a pricing threshold, in this case, the difference between the loan’s annual percentage rate and the average prime offer rate for a comparable transaction.
But Fitch claims that the pricing threshold, which it refers to as spread to APOR (the spread over the average prime offered rate), is a good indicator of default risk, but is not as reliable as DTI.
“DTI is a better measure of a borrower’s ability to repay a new mortgage loan without having to sell the home or leverage existing equity if financially stretched, which is the primary purpose of the ATR Rule,” Fitch writes in its report.
As Fitch writes, the success of using DTI as an underwriting criterion is shown in the overall performance of mortgages since the housing crisis.
“Mortgage origination standards since the crisis were some of the most stringent in recent history limiting mortgage credit to only the most qualified borrowers,” Fitch writes. “Yet, even with the most restrictive qualification standards, DTI remains a key predictor of borrower default.”
According to Fitch, the use of spread to APOR may not bring as wholistic of a view of a borrower’s ability to repay as DTI.
“Spread to APOR is a good measure of default risk. However, many factors can affect the price of a loan, some of which may have little to do with the borrower’s repayment capacity; these include liquidity, market movements, or attributes that present a low risk of loss to the lender, for example, a low loan-to-value,” Fitch writes.
“Aggressive lending programs could result in borrowers having a low APR but a high DTI and LTV where they cannot afford the loan but the risk of loss to the lender is low,” Fitch adds.
On the other hand, Fitch notes that DTI does not “fully capture” a borrower’s default risk.
“For example, a high-income borrower with a 50% DTI may be better able to afford a new loan than a low-income borrower with a 25% DTI,” Fitch writes. “Additionally, DTI does not capture all household expenses and, importantly, is calculated based on gross income without consideration for taxes. In part, because of these limitations, DTI historically has not been as strong a predictor of default as LTV and credit score.”
As stated earlier, moving away from DTI does have its supporters. Bank of America, Quicken Loans, Wells Fargo, Caliber Home Loans, along with the Mortgage Bankers Association, the American Bankers Association, the National Fair Housing Alliance and others asked the CFPB last year to do away with the DTI requirement.
Earlier this week, former Federal Housing Finance Agency Interim Director Ed DeMarco told HousingWire that he supports moving away from DTI to determine QM, but is withholding judgement on the CFPB plan until he sees how exactly the alternative would function.
But Fitch takes the opposite view and wants DTI to remain part of the underwriting equation.
“Despite the weaknesses, DTI serves as a guardrail that helps protect borrowers from obtaining a mortgage they otherwise could not afford and can indicate whether the loan was originated reasonably and in good faith,” Fitch writes.
“DTI also provides broader value in the form of a countercyclical affordability constraint,” Fitch adds. “In periods of unsustainable home price growth, where prices are far outpacing income growth, DTI can act as safety valve to help contain demand as unaffordability lessens demand, which slows home price growth.”