Someone Forgot to Tell Fannie, Freddie About Lowering Debt Ratios

Sufficient Income Key To Sound Home Ownership

In an effort to prevent delinquent home owners from losing their homes to foreclosure, the Department of the Treasury recently issued guidelines to lenders. Under the Making Home Affordable mortgage modification program, the Treasury stated that the mortgage loans for at risk home owners should be modified to result in a front end debt ratio of 31%. A front end debt ratio is the percentage of gross monthly income that is spent on housing costs, typically principal, interest, taxes and insurance.

Historically, a front end debt ratio of around 31% was considered to be an affordable portion of a borrower's gross income to allocate to housing. A housing debt ratio in this range allowed the borrower sufficient remaining income to cover other living costs and debt payments.

DEPARTMENT OF THE TREASURY
Office of the Comptroller of the Currency, Joint Statement of June 23, 2009 (pdf file)

On March 4, 2009, Treasury announced guidelines under the Program to promote sustainable loan modifications for homeowners at risk of losing their homes due to foreclosure.

Under the Program, Treasury will partner with lenders and loan servicers to offer at-risk homeowners loan modifications under which the homeowners may obtain more affordable monthly mortgage payments.

The Program guidelines require the lender to first reduce payments on eligible first-lien loans to an amount representing no greater than a 38 percent initial front-end debt-to-income ratio. Treasury then will match further reductions in monthly payments with the lender dollar-for-dollar to achieve a 31 percent front-end debt-to-income ratio. Borrowers whose back-end debt-to-income ratio exceeds 55 percent must agree to work with a foreclosure prevention counselor approved by the Department of Housing and Urban Development.

The OCC guidelines corresponded to comments by the Secretary of HUD, Shaun Donovan, who had previously supported lowering the debt ratios of at risk homeowners to 31%. In response to the question as to why so many home owners default after having a mortgaged modified, Mr. Donovan stated the obvious - if a mortgage payment was excessive compared to income, default was much more likely.

What it showed was that where there’s actually a reduction in payments, there’s long-term success for those homeowners. People do much better when you lower payments and make them affordable than these other so-called modifications, which actually keep payments the same or increase them.

So I saw it, and in fact, if you look at the report, some of the language in it directly supports the way that we’re setting up our plan to create a standard that is truly affordable for borrowers. 31 percent debt-to-income ratio is the right standard. It’s widely accepted, and if we can get to that level, as we do in our plan, we believe that that sets us up, based on the results of the study, for long-term success for homeowners.

Someone Should Tell The GSEs

The HUD Secretary’s comments make sense and reflect previous sound underwriting guidelines that existed prior to the housing lending mania of the bubble years. If mortgage lenders had not abandoned traditional income requirements, borrowers would not have been approved at debt ratios that virtually guaranteed future defaults. The Treasury and HUD are promoting sound lending policies when they recommend a conservative debt ratio.

The problem is that someone forgot to tell Fannie Mae (FNM), Freddie Mac (FRE) and especially the FHA what HUD and the OCC have proposed as a safe debt ratio. (See Why Does The FHA Approve Loans That Borrowers Cannot Afford.) We now have the absurdity of lenders being required (at taxpayer expense) to modify mortgages to a 31% debt ratio while it is extremely common to see new mortgages being approved at debt ratios of 50% or higher. When a borrower is paying out half of pre tax income for housing expenses, there is usually barely enough left for other debt payments, living expenses, home repairs, etc. A reduction in income, a major unexpected home repair bill or any other unexpected expense can be enough to tip the borrower into default. Yet, the automated underwriting systems of Fannie, Freddie and the FHA are routinely approving risky mortgage loans at debt ratios far in excess of 31%.

The government’s obsession with increasing housing sales and refinances has resulted in a bizarro world situation. Mortgages are being approved with unaffordable payments, the borrower falls behind and then the payments are modified lower under the Making Home Affordable program. It’s not surprising that the Federal Reserve has had to become the buyer of last resort of mortgage backed securities - who else would want to buy them?

Disclosures: No positions.

Comments

[District Ba...:]

Someone also forgot to tell owners of FNM/FRE common that the holders of those companies respective preferred stock (primarily banks/thrifts and insurance co's) have already written off their investments.

Not sure why common holders expect to get anything when the preferred holders have already recognized a loss...

Jul 13 10:38 AM

[mortgagedaddy:]

I have to correct you, sir. It is NOT common to see mortgages approved with a ratio (like the one you speak of) at or above 50%. I am a mortgage broker and the ratio in your blog of 31% is the font end ratio or top ratio. It refers to the individual's % of gross monthly income going toward the monthly payment. It would be a shocker to me for someone with a front ratio of 50% to get approved for a conventional or FHA loan. Now, the back end or bottom ratio, which is the percentage of gross monthly income going toward all monthly credit report debt including the new mortgage, does get approved sometimes even if it's over 50%. You have to be clear. To say 31% is good, but loans are getting approved with % over 50, is wrong.

Jul 13 01:46 PM

[Bill Zielinski:]

I was primarily speaking of the front end debt ratio. The point is, if mortgages are being modified to 31% and HUD is saying that this is a proper and safe debt ratio, why are new loans being approved at much higher front end debt ratios? I commonly see approvals with a back end ratio in the mid 40's or low 50's which, as I noted, probably puts way too much stress on a homeowner's financial situation.

For those borrowers with little other debt, many are approved with a front end ratio far in excess of the HUD recommended front end ratio of 31%. The government's policies are inconsistent.
Also, each bank can apply different rules as well; here's a summary of one major bank that announced they were "tightening" debt ratios (in this case, the back end).

"Important Update Regarding Revised Maximum Debt-to-Income (DTI) Ratios on all AUS
Approved Government Loans
Effective for new locks on or after Monday, March 2, 2009, the maximum debt-to-income (DTI)
ratio for all AUS approved government loans will be fifty percent (50.00%) regardless of the
AUS approval or recommendation. This new requirement applies to FHA and VA loans
approved through DU/DO and/or LP.

Bottom line - a lot of borrowers are still being approved and taking on payments that probably can't be handled in the long term


On Jul 13 01:46 PM mortgagedaddy wrote:

> I have to correct you, sir. It is NOT common to see mortgages approved
> with a ratio (like the one you speak of) at or above 50%. I am a
> mortgage broker and the ratio in your blog of 31% is the font end
> ratio or top ratio. It refers to the individual's % of gross monthly
> income going toward the monthly payment. It would be a shocker to
> me for someone with a front ratio of 50% to get approved for a conventional
> or FHA loan. Now, the back end or bottom ratio, which is the percentage
> of gross monthly income going toward all monthly credit report debt
> including the new mortgage, does get approved sometimes even if it's
> over 50%. You have to be clear. To say 31% is good, but loans are
> getting approved with % over 50, is wrong.

Jul 13 09:42 PM

[Taylor McKe...:]

You can get a free Homeowner's Guide on President Obama's "Making Home Affordable" plan at MortgageCreditTrauma.c....

This plan outlines the rules and eligibility guidelines for 1st & 2nd loan modifications as well as giving a Loan Comparison Chart for Countrywide/BofA, CitiGroup/CitiMortgage, IndyMac Fed Bank and JP Morgan who is also accepting Washington Mutual and EMC Mortgage Corp customers.

Hope this helps!

Jul 14 06:55 PM