WASHINGTON — When the Consumer Financial Protection Bureau finalized its mortgage underwriting rule in 2013, it granted government-backed loans an exemption. Years later, the government-backed market appears to be enjoying the benefits, sparking a debate about whether the exemption should remain.
The CFPB rule essentially freed loans backed by the government-sponsored enterprises and other agencies from complying with a debt-to-income maximum imposed on other mortgages. Yet recent growth in loans with higher debt-to-income has prompted a debate over the exemption. The Trump administration says it gives government-backed loans an unfair advantage.
"We are seeing lenders expanding the credit box," said Paul Noring, managing director and practice leader at the financial services and regulatory consulting firm Navigant. "Underwriters are definitely pushing on the DTI limits to try to approve more borrowers. Some lenders are being more aggressive than others."
The CFPB rules required lenders to evaluate borrowers’ ability to repay, except for designated “qualified mortgages” (or QM) that meet criteria for safe loans, including a maximum debt-to-income ratio of 43%. But loans backed by the government-sponsored enterprises Fannie Mae and Freddie Mac as well as other agencies such as the Federal Housing Administration automatically earn QM status even if they have higher DTIs.
The exemption that applies to the GSEs — commonly known as the QM Patch — will last as long as Fannie and Freddie are in federal conservatorship, or until January 10, 2021. Agencies such as the FHA and Department of Veterans Affairs, meanwhile, were authorized to write their own QM rules without imposing a DTI limit.
For some agencies, higher-DTI loans are already seen as a growing and sizable part of the government-backed portfolio.
More than half of FHA purchase loans have DTIs above 43% as of April 2017, up from 36% in February 2013, according to data compiled by the American Enterprise Institute's International Center on Housing Risk. And 41% of VA purchase loans have DTIs above 43%.
These high back-end DTI ratios allow borrowers to purchase higher-priced homes with the same amount of income. "That is what really is helping to drive this market," said Edward Pinto, a resident fellow at AEI, at a housing conference last month.
But it is less clear at this point whether Fannie and Freddie are doing the same. In July, Fannie relaxed its limits to approve loans with 45% to 50% DTI ratios. Previously, Fannie borrowers in that DTI range were required to have significant reserves and equity to be approved for a mortgage. Freddie Mac has allowed DTI ratios above 43% since 2011.
At the housing conference, Pinto said, “We haven’t seen any effect yet” from Fannie's recent policy change. However, in a subsequent interview Pinto said he has heard anecdotally of the GSEs backing higher-DTI loans.
“I have spoken with a significant market participant who has told me that they are seeing substantial increases in total DTI ratios above 45% at the GSEs,” he said.
Some are concerned rising DTIs will only lead to higher prices and riskier loans. But others note that lenders have been too stringent in what they count toward income, and that more lenient DTI ratios combined with favorable status under the CFPB rules open up the housing market to a wider scope of borrowers.
"Credit availability is tighter than it should be, and I would argue that loosening DTIs would be a good thing," Laurie Goodman, co-director of the Housing Finance Policy Center at the Urban Institute, said in an interview.
Peter Tobias, a senior research analyst at AEI, said while the higher DTIs do help new home buyers, they also can distort the market.
"Looser lending standards by the government agencies is allowing first-time buyers to offset higher prices," Tobias said. "However, the extra leverage from looser lending is driving up prices in today's seller market, while also posing risks for first-time buyers.”
In its June report recommending changes to financial regulatory policy, the Treasury Department said higher-DTI loans that are allowed through the GSEs’ QM Patch and other federal guarantee programs, while other mortgages must stick to the CFPB’s strict limits, create “an asymmetry, and regulatory burden, for privately originated mortgages.”
The Treasury report recommended that the CFPB should eliminate the exemption for GSEs. But it also suggested that all market participants could be eligible for more flexible DTI limits.
“The CFPB should engage in a review of the ... rule and work to align QM requirements with GSE eligibility requirements, ultimately phasing out the QM Patch and subjecting all market participants to the same, transparent set of requirements,” the report said. “These requirements should make ample accommodation for compensating factors that should allow a loan to be a QM loan even if one particular criterion is deemed to fall outside the bounds of the existing framework — e.g., a higher DTI loan with compensating factors.”
The administration is planning to review the QM rule because it is simply funneling the business to Fannie, Freddie and the FHA, according to Mark Calabria, an adviser to Vice President Mike Pence and a former Senate Banking Committee staffer.
"We are re-examining the uncertainty caused by the qualified mortgage rule," Calabria said at a CoreLogic/Urban Institute joint housing conference Wednesday. "We want a world where lenders are willing to take credit risk and we are not in that world today.”
Calabria noted that the post-Dodd-Frank Act regulatory regime discourages private capital from taking mortgage credit risk.
"Unless there is a fix for QM, private capital is not going to come into" the mortgage market, he said. "It is not a healthy situation for the taxpayer or the real estate industry."
But observers said a longer-term policy on the QM status for GSE-backed loans would also remove uncertainty created by the 2021 expiration date for the current GSE exemption.
Making loans available that would otherwise be unaffordable “is helpful for consumers,” but “there is a concern that the QM patch expires January 10, 2021,” said Robert Lotstein, managing attorney for LotsteinLegal PLLC based in Washington, D.C. “It is never too early to start thinking about a permanent solution, especially given the data we have so far.”
Goodman noted that DTI ratios are rising and they are likely to continue to rise. And first-time buyers are a bigger share of the market today than repeat buyers. However, lenders are more "stringent" in their definition of income compared to the early the 2000s before the housing boom, she said.
"We are very cautious in what we count toward income right now," Goodman said. Those restrictions come into play, for example, when a borrower hasn't held the same job for two years or has a second job.
"So income today is often undercounted compared to 2003 whereas it used to be counted more generously," she said.
Meanwhile, the housing market is transitioning from a refinancing to a purchase market and total originations are expected to decline for a second straight year, according to economists at the Mortgage Bankers Association. Total single-family originations topped $2 trillion in 2016. And MBA estimates originations will come in around $1.69 trillion by yearend 2017.
The MBA forecasts that in 2018 lenders will originate $1.6 trillion in home loans, and $1.2 trillion will be purchase loans.
"DTI ratios become much more important in a purchase market," Noring said.
Yet credit is generally strong and delinquency rates are still very low, he added.
"Even if you are pushing out on the DTI ratios a little bit, yes, they are taking on more risk … but you are doing it for borrowers who are generally at the lower end of their careers and they have an ability to expand their income over time," Noring said.