DTI Has Risen for Conventional Conforming Loans

Mortgage Credit Risk Trends for Fourth Quarter 2018 Finds Higher Debt-to-Income Ratios

By Archana Pradhan Housing Affordability, Mortgage Finance

Average debt-to-income (DTI) ratios for conventional conforming (CC) home-purchase loans rose during the fourth quarter of 2018 and were the highest since 2009.[1] In contrast, the average loan-to-value (LTV) during this time was unchanged from the same quarter in 2017. Additionally, the average credit score was about the same. On net, the rise in DTI ratios may reflect the growing affordability pressures for homebuyers in the face of rising mortgage rates in the latter months of 2018.

To expand the credit box to creditworthy borrowers, Fannie Mae began accepting mortgages with LTV ratios up to 97 percent in December 2014. Freddie Mac began accepting them in March 2015. To further expand access to credit, Fannie Mae raised its DTI ratio level from 45 to 50 percent in July 2017. DTI and LTV ratios, along with credit scores, are three important factors in mortgage underwriting.

Share of Conforming Conventional Home-Purchase

The credit-risk attributes of borrowers have shown dramatic variation in the last 19 years. Recent credit-loosening policies by the Government-Sponsored Enterprises (GSEs) have helped boost higher DTI and LTV ratios. Figure 1 shows the share of new conventional conforming home-purchase loans with a DTI ratio above 45 percent rose sharply after Fannie Mae enacted its new policy. The share, holding steady between 5 to 7 percent from early 2012 up to Fannie Mae’s announcement, had reached 21 percent in the fourth quarter of 2018. The average DTI ratio for CC home-purchase loans rose by one point to 37 percent from the fourth quarter of 2017 to the fourth quarter 2018.

Share of Conforming Conventional

Similarly, Figure 2 shows that the share of new CC home-purchase loans with an LTV ratio above 95 percent started to rise in early 2015 following the GSEs’ announcement. The share was less than two percent in 2014 but rose gradually and reached 10 percent in the last quarter of 2018. The average LTV ratio for the home-purchase loans in the fourth quarter of 2018 was 82 percent, unchanged from the same quarter of 2017.

Though both DTI and LTV standards have been relaxed, there has been no change in credit score standards. During the fourth quarter of 2018, the average credit scores for the homebuyers with CC home-purchase loans dipped by one point from the same quarter in 2017. However, the average credit score was much higher than the pre-housing crisis level. For example, the average credit score of homebuyers was 705 in 2001, but dramatically rose during the Great Recession in 2008, and was 754 in the fourth quarter of 2018. In addition to high credit score standards, those high DTI and LTV loans in 2018 were fully documented and are thus different than the pre-housing crash high DTI and LTV loans, in which many of the latter were low/no documentation loans.

Six Credit-Risk AttributesNote: The share of loans made during 2001-2002 with the credit-risk attribute shown on the axis are set equal to 100.

Figure 3 compares six indicators of underwriting and credit risk during a benchmark time period to present day for CC home-purchase loans. The blue hexagon represents an index of credit-risk attributes in the benchmark period and the red polygon represents characteristics of loans originated in the fourth quarter of 2018, relative to the benchmark. The share of borrowers with a credit score less than 640 as well as the low/no documentation loan share were both down significantly compared to the 2001-2002 benchmark level. In contrast, the shares of new loans with an LTV ratio higher than 95 percent and with a DTI ratio above 45 percent were 63 percent and 36 percent, respectively, both higher than the benchmark level. The condo/co-op share was 6 percent higher than the benchmark level, while the investor-owned share was 5 percent lower than the benchmark level.

Both mortgage rates and home-sale price continued to rise throughout the last quarter of 2018 while wage growth was almost stagnant.[2] The rise in share of loans with a DTI ratio above 45 percent reflects the affordability pressure caused by the widening gap between home-price appreciation and wage growth.

[1] Conventional conforming loans are those that generally meet standards for sale set by Fannie Mae and Freddie Mac. Based on CoreLogic Public Records data for the fourth quarter of 2018, these loans contribute to approximately 71 percent of all purchase-mortgage loans.

[2] For wage growth see BLS website

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