Taking on more mortgage, debt to get easier
Fannie Mae is making it easier for some borrowers to spend up to half of their monthly pretax income on mortgage and other debt payments. But just because they can doesn’t mean they should.
“Generally, it’s a pretty poor idea,” said Holly Gillian Kindel, an adviser with Mosaic Financial Partners. “It flies in the face of common financial wisdom and best practices.”
Fannie is a government agency that can buy or insure mortgages that meet its underwriting criteria. Effective July 29, its automated underwriting software will approve loans with debtto-income ratios as high as 50 percent without “additional compensating factors.” The current limit is 45 percent.
Fannie has been approving borrowers with ratios between 45 and 50 percent if they had compensating factors, such as a down payment of least 20 percent and at least 12 months worth of “reserves” in bank and investment accounts. Its updated software will not require those compensating factors.
Fannie made the decision after analyzing many years of payment history on loans between 45 and 50 percent. It said the change will increase the percentage of loans it
approves, but it would not say by how much.
That doesn’t mean every Fannie-backed loan can go up to 50 percent. Borrowers still must have the right combination of loan-to-value ratio, credit history, reserves and other factors. In a statement, Fannie said the change is “consistent with our commitment to sustainable homeownership and with the safe and sound operation of our business.”
Before the mortgage meltdown, Fannie was approving loans with even higher debt ratios. But 50 percent of pretax income is still a lot to spend on housing and other debt.
The U.S. Census Bureau says households that spend at least 30 percent of their income on housing are “costburdened” and those that spend 50 percent or more are “severely cost-burdened.”
The Dodd-Frank Act, designed to prevent another financial crisis, authorized the creation of a “qualified mortgage.” These mortgages can’t have certain risky features, such as interest-only payments, terms longer than 30 years or debt-to-income ratios higher than 43 percent. The Consumer Financial Protection Bureau said a 43 percent limit would “protect consumers” and “generally safeguard affordability.”
However, loans that are eligible for purchase by Fannie Mae and other government agencies are deemed qualified mortgages, even if they allow ratios higher than 43 percent. Freddie Mac, Fannie’s smaller sibling, has been backing loans with ratios up to 50 percent without compensating factors since 2011. The Federal Housing Administration approves loans with ratios up to 57 percent, said Ed Pinto of the American Enterprise Institute Center on Housing Risk.
Since 2014, lenders that make qualified mortgages can’t be sued if they go bad, so most lenders have essentially stopped making non-qualified mortgages.
Lenders are reluctant to make jumbo loans with ratios higher than 43 percent because they would not get the legal protection afforded qualified mortgages. Jumbos are loans that are too big to be purchased by Fannie and Freddie. Their limit in most parts of the Bay Area is $636,150 for one-unit homes.
Fannie’s move comes at a time when consumer debt is soaring. Credit card debt surpassed $1 trillion in December for the first time since the recession and now stands behind auto loans ($1.1 trillion) and student loans ($1.4 trillion), according to the Federal Reserve.
That’s making it harder for people to get or refinance a mortgage. In April, Fannie announced three small steps it was taking to make it easier for people with education
loans to get a mortgage.
Some consumer groups are happy to see Fannie raising its debt limit to 50 percent. “I think there are enough other standards built into the Fannie Mae underwriting system where this is not going to lead to predatory loans,” said Geoff Walsh, a staff attorney with the National Consumer Law Center.
Mike Calhoun, president of the Center for Responsible Lending, said, “There are households that can afford these loans, including moderate-income households.” When they are carefully underwritten and fully documented “they can perform at that level.” He pointed out that a lot of tenants are managing to pay at least 50 percent of income on rent.
A new study from the Joint Center for Housing Studies at Harvard University noted that 10 percent of homeowners and 25.5 percent of renters are spending at least 50 percent of their income on housing.
When Fannie calculates debt-to-income ratios, it starts with the monthly payment on the new loan (including principal, interest, property tax, homeowners association dues, homeowners insurance and private mortgage insurance). Then it adds the monthly payment on credit cards (minimum payment due), auto, student and other loans and alimony.
It divides this total debt by total monthly income. It will consider a wide range of income that is stable and verifiable, including wages, bonuses, commissions, pensions, investments, alimony, disability, unemployment and public
assistance.
Fannie figures a creditworthy borrower with $10,000 in monthly income could spend up to $5,000 on mortgage and debt payments. Not everyone agrees.
“If you have a debt ratio that high, the last thing you should be doing is buying a house. You are stretching yourself way too thin,” said Greg McBride, chief financial analyst with Bankrate.com.
Michelle Brownstein, director of private client services with Personal Capital, agrees. A rule of thumb is to spend no more than 28 percent of income on housing and no more than 36 percent on all debt. That lets people “live comfortably,” pay taxes and save for retirement, college and emergencies, she said.
“You can make the argument, for some individuals, that a higher (ratio) makes sense if their income is going to go up dramatically in a short period of time,” or if they have reserves earning 7 or 8 percent in an investment account and a 4 percent mortgage, she added.
Of course, spending no more than 28 percent of income on housing is not realistic for many people in the Bay Area. According to the California Association of Realtors, only 25 percent of people here had enough monthly income ($13,362) to make the monthly payment including taxes and insurance ($4,010) on a median-priced singlefamily home ($780,3330), in the first quarter.
Many buyers are afraid to go that high. “We have buyers balk at going to 45 percent, much less 50 percent,” said Jay Vorhees, a mortgage broker in Walnut Creek. This is especially true with Millennials.
Borrowers who are refinancing a mortgage and taking cash out to pay off other debt may be tempted to go up to 50 percent, especially if they are already spending at least 50 percent of income on debt. This move seems appealing, because interest on homeequity debt is deductible — up to a limit — whereas interest on other debt is not. But converting short-term consumer debt into 30-year mortgage debt is not always a smart move.
Kindel, the financial adviser, said borrowers should talk over such moves with a “financial thinking partner who doesn’t have a vested interest” in the decision. That excludes mortgage and real estate agents and even some family members.
“If this is data-driven as Fannie says, I guess it’s OK,” said David Reiss, who teaches real estate finance at Brooklyn Law School. “People can make decisions themselves. We have these rules for the median person. A lot of immigrant families have no problem spending 60 or 70 percent (of income) on housing. They have cousins living there, they rent out a room.”
Reiss added that homeownership rates are low and expanding them “seems reasonable.” But making credit looser “will probably drive up housing prices.”