Heeding the call of some of the largest mortgage lenders in the industry, the Consumer Financial Protection Bureau (CFPB) is moving to back the elimination of debt-to-income (DTI) requirements in mortgage underwriting.
In a letter CFPB Director Kathy Kraninger sent to Congress today, the CFPB asked to amend the Ability to Repay/Qualified Mortgage rule (ATR/QM rule) in order to remove DTI as a qualifying factor in mortgage underwriting.
This rule was created in response to the financial crisis of a decade ago as a way to prevent lending money to borrowers who might not be able to afford the loan. The ATR/QM rules includes eight separate borrower qualifications that lenders must examine when approving a loan. The rule includes things like verification of income, credit history and DTI, among others. The only portion the CFPB is asking to amend is the DTI requirement as a powerful coalition of lenders deems the rule unfair and constraining.
In September, a group of lenders and industry groups, including Wells Fargo, Bank of America, Quicken Loans, Caliber Home Loans, the Mortgage Bankers Association, the American Bankers Association, the National Fair Housing Alliance, and others, sent a letter to the CFPB, asking the bureau to remove the 43 percent DTI requirement on both prime and near-prime loans.
One reason for the request is that GSEs Fannie Mae and Freddie Mac are not subject to this rule, under a condition called the “QM Patch.” This patch allows loans sold to Fannie and Freddie to exceed the 43 percent DTI requirement, which some lenders say is unfair for those loans backed by private capital.
The 43 percent DTI rule also doesn’t apply to government-insured loans such as FHA, VA or USDA mortgages.
The risks of eliminating DTI requirements
During the height of the financial crisis, in 2008 and 2009, some 3 million foreclosures were filed each year. As a way to prevent another catastrophe, the Dodd-Frank Wall Street Reform and Consumer Protection Act was enacted, which created the CFPB.
Although the economy has recovered, some argue that easing important lending safeguards could pave the way for problems in the future.
“Eliminating debt-to-income ratios from underwriting guidelines will result in more loans to consumers with already heavy debt loads and is reminiscent of Congress requiring Fannie and Freddie to buy more subprime loans. That didn’t end well,” says Greg McBride, CFA, Bankrate chief financial analyst.
McBride says that the DTI requirement has long been a standard in borrowing, so removing it outright could mean a free-for-all in the mortgage lending space.
“The 43 percent DTI standard came about after the goal posts were moved from the previous, long-held standard of 36 percent,” McBride says. “Now they want to just take the goal posts off the field altogether.”
Although DTI is an important measure in determining a borrower’s ability to repay a loan, McBride points out, it’s important to understand what’s behind the number. For instance, two people might have the same DTI but a very different financial profile.
“Take two different borrowers, each with a 43 percent DTI,” McBride says. “One has a monthly income of $10,000 and the other just $4,000. The higher income borrower has $5,700 remaining after monthly debt obligations whereas the lower income borrower has just $2,280 left over. Through that lens, the lower income borrower might look riskier than a higher-income borrower with more financial wiggle room.”