Mortgage Credit Underwriting Eased During Past Year

Q2 2018 vs one year earlier: Conventional has higher DTI, FHA higher DTI and lower credit score

By Archana Pradhan Mortgage Finance, Risk Management

Mortgage credit underwriting eased for both conventional and Federal Housing Administration (FHA) home-purchase loans during the Q2 2018 compared with a year earlier. FHA underwriting standards are more relaxed than conventional in terms of credit requirements. In the last few years, GSEs have expanded their credit box to creditworthy borrowers by increasing the maximum debt-to-income (DTI) and loan-to-value (LTV) ratios. In this update, we analyze the averages of three key factors in mortgage underwriting: DTI, LTV, and credit scores. Since looking at averages does not necessarily indicate these loans pose a higher risk to the housing market, we also analyze the trend at the highest risk spectrum: the share of loans with very high DTI and LTV, and share of loans with low credit scores.[1]

Share of Conventional and FHA Home Purchase Loans

The average DTI for conventional home-purchase loans has risen steadily since mid-2013, and started to rise sharply after Fannie Mae raised its DTI ratio level from 45 to 50 percent in July 2017. The average DTI ratio for conventional loans rose by two points from Q2 2017 to almost 37 percent in Q2 2018. Similarly, DTI for FHA loans started to rise after Q2 2015 and had reached its highest level in at least 14 years during Q2 2018 at 43 percent, up from 42 percent in Q2 2017. The share of loans with DTI ratio above 45 percent has increased for both the conventional and FHA products (Figure 1). For conventional loans, it rose sharply after Fannie Mae’s move. The share, holding steady at between 5 percent to 7 percent from early 2012 up to Fannie Mae’s announcement, had reached 20 percent in Q2 2018. Similarly, the share of FHA loans with DTI ratio above 45 percent had increased to 38 percent in Q2 2018.

Average Loan to Value Ratios in Percent

Figure 2 shows the average LTV for FHA loan originations has remained steady at around 96-97 percent for more than a decade. However, the average LTV for conventional loans rose steadily from 76 percent in Q2 2010 to 82 percent in Q2 2018. For both FHA and conventional loans, the average LTV ratios in Q2 2018 remained unchanged from Q2 2017. The share of conventional loans with LTV ratio above 95 percent started to rise in early 2015 following the GSEs announcement that they would buy loans with less than 5 percent down payment. The share was less than two percent in 2014 but rose gradually and reached 9 percent in Q2 2018. In contrast, the share of FHA loans with LTV ratio above 95 percent has remained steady around 87-89 percent in last couple of years.

Historically, FHA has played a key role in opening access to credit. The average credit score for homebuyers with FHA loans has been lower than for buyers with conventional loans (Figure 3). Since Q2 2011, the average credit score of homebuyers with FHA loans has declined steadily (709 in Q1 2011 to 681 in Q2 2018) making loans more accessible to borrowers with moderate credit history. However, the average credit score of homebuyers with a conventional loan has been relatively unchanged and remained in a range of 758-763 since 2009. Looking at the high-risk tail, the share of borrowers with a credit score less than 640 is just 1 percent for conventional loans compared with 18 percent for FHA loans originated in Q2 2018.

Average Credit Scores of Homebuyers

Though both DTI and LTV standards have been relaxed since 2015, there has been no easing in credit score standards. In fact, the average credit scores for both FHA and conventional loans were much higher in Q2 2018 than the pre-crises level. High credit score standards and full documentation help offset the added risk from high LTV/DTI loans in Q2 2018.

[1] Loans here indicate only owner-occupied, first-lien, new FHA and conventional purchase-money originations.

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