Nothing but Net a Better Focus Than Gross

JAN 16, 2013 2:26pm ET
Comments (2)

WE’RE HEARING…reviews on the long-awaited CFPB qualified mortgage rule are mixed, with some saying the rules were too restrictive while others pointing out that the best lenders were already lending along these lines.

To me, the interesting part of the rule is not what is in there, but rather what is missing. 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. As industry veterans, shouldn’t we be focused on something other than gross? Maybe focusing on the gross shouldn’t have the audience appeal it had in middle school (although being gross still has its appeal).

Let me explain my attitude about being gross.

In the new rule, there is a lot of attention paid to the debt-to-income calculation, which makes sense because that’s one of the most important metrics we use as an industry in our underwriting process.

The new rule requires that we use a 43% “back ratio” as a de-facto maximum qualifying criterion for new mortgages. So, when underwriting a mortgage loan, a lender is instructed to ensure that the total monthly debt payments do not exceed 43% of the consumer’s gross monthly income.

This is supposed to make us feel comfortable about the consumer’s ability to actually repay the loan. It also offers the lender some safe harbor from litigation.

There is an exemption to the 43% rule for GSE loans approved through automated underwriting, but that is not entirely comforting to lenders due to the lack of transparency regarding automated approvals—you are never really sure what will get approved by AU, especially as the GSEs evolve in the new regulatory climate.

For originators, it’s sort of underwriting roulette—you load up the AUS, take a shot and hope the loud bang of rejection does not blow away the chance to get the loan done. But I digress.

So, the important DTI ratio suggests that gross income is the most important driver of ability to pay. But is gross income a reliable indicator? As we all know, the take home pay is adjusted by many variables that are different based on personal situations, such as payroll and local taxes (which vary from 0-10% of gross pay), health insurance costs and retirement deductions.

There are a lot of variables that reduce the gross to the net, but what is certain is that the gross number means little to a consumer trying to pay their bills each month. In fact, it’s pretty close to imaginary to them.

It may not make a lot of sense to base underwriting solely on a metric on something that doesn’t appear in the real world. Next week, I’ll give you another reason I think we should do more than just be gross about qualifying criteria such as DTI.

Garth Graham is a partner with STRATMOR Group, and has over 25 years of mortgage experience, from Fortune 500 companies to successful startups, including management of two of the most successful mortgage e-commerce platforms. He is a former senior vice president of ABN Amro and Citi Mortgage.

Comments (2)
You are looking for CFPB guidelines that make sense? I wish you luck.
Posted by | Thursday, January 17 2013 at 12:03PM ET
I agree wholeheartdly, especially when Congress is going to mess with tax code (write offs, etc) over the coming months and years. Having worked with low income families thru the Fuller Center for Housing, I know that getting tax refunds is how some of these people make ends meet. When that goes away, where will they be? By using NET income, it will be easier to help borrowers purchase homes they can manage. The other piece to the puzzle, is that there is no allowance for property maintance. A house built in 2010 is going to require less repair (we hope) than one built in 1940, but we don't take any of that into consideration as lenders. Keep up the good work and let the CFPB folks know about your thoughts, Garth.
Posted by | Friday, January 18 2013 at 12:13PM ET
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