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Gross Is for Kids, Not Ability to Repay

JAN 23, 2013 2:39pm ET

WE’RE HEARING…back from you, and thanks for responding! Last week, I pointed out that only middle schoolers could really excel in the sport of leveraging gross for mass appeal, a comment that resulted in no shortage of email last week. Thank you, one and all. I talked about the imaginary nature of gross income, at least in the minds of consumers. But there are other reasons I think gross is incomplete.

The context was the long-awaited qualified mortgage rule issued by the CFPB a week or so ago. The rule, as you may recall, focused on the consumer’s “ability to repay” and how that would impact the underwriting standards for the industry.

As an industry, we have always had too great a focus on GROSS income, and not enough focus on the consumer’s real bottom line.

The use of a ratio based on gross income assumes that consumers look at debt and monthly payments the way lenders do. By only counting the debt that is on the credit report (i.e., the debt paid to financial institutions) we are ignoring the payment patterns of a specific or even a typical household.

Payment patterns and the burden of food, clothing, shelter and transportation will vary with family size, ages of household members, health and geography. While a vast majority of consumers pay their mortgage on time every month, they don’t necessarily prioritize to pay it first.

One thing we learned during the housing crisis is that consumers in trouble may pay their bills differently than we as mortgage lenders expect—they may start with the car payment, it’s the way they get to work and earn the money for next month’s bills and it will get repossessed if not paid on time. Then they pay for gas to keep it running, child care to see to the kids during working hours, food to feed them when they are picked up and utilities to keep them warm overnight.

Then, if there is enough left, they pay their mortgage. That is how families often budget, using much of their net income on expenses that don’t show up on a credit report.

As an industry, we know that budgeting is important, as evidenced by the fact that when consumers get behind on their mortgage and end up in the loss mitigation department or at a nonprofit housing agency, the counselor’s first question is, “How much do you bring home?”

That is the basis of the consumer’s home budget, that magic tool that advocates say is the starting point to financial security and figuring out what a mortgagor can actually afford.

In fact, nearly all commercial mortgage applications are analyzed through cash-flow analysis, which is basically an analysis of a company’s ability to manage to a budget. So, if budgeting is a good tool to use to figure out how to help a homeowner who is in trouble, then perhaps it should be used as a way to keep mortgagors (and lenders) out of trouble, too.

I’ll have one more thing to say about this next week and then it’s off to other problems that need solving.

Garth Graham is a partner with STRATMOR Group, and has over 25 years of mortgage experience, from Fortune 500 companies to startups, including management of two of the most successful mortgage e-commerce platforms. He was formerly with Chase Manhattan Mortgage and ABN Amro, where he was a senior executive during the sale of its mortgage group to Citigroup.