Low Mortgage Rate Helps to Lower DTI Ratio for Conventional Conforming Loans

Mortgage Credit Risk Trends for Third Quarter 2019 Finds Lower Debt-to-Income and Higher Loan-to-Value Ratios Compared with One Year Ago

By Archana Pradhan Consumer Behavior, Mortgage Finance

 Average debt-to-income (DTI) ratios for conventional conforming home-purchase loans dropped during the third quarter of 2019 from the same quarter in 2018. In contrast, the average loan-to-value (LTV) ratios during this time rose. Additionally, the average credit score rose. On net, the drop in DTI ratios may reflect the relaxing of affordability pressures for homebuyers in the face of declining mortgage rates in 2019.

Figure 1 Share of Conforming Conventional Home-Purchase Loans with DTI Ratio Above 45 Percent

The credit-risk attributes of borrowers have shown dramatic variation in the last 20 years. DTI and LTV ratios, along with credit scores, are three important factors in mortgage underwriting. Since 2014, credit-loosening policies by the Government-Sponsored Enterprises (GSEs) have helped boost higher DTI and LTV ratios.[1] 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 to its peak of 21 percent in the fourth quarter of 2018 and started dropping in early 2019. The average DTI ratio for conventional conforming home-purchase loans dipped by one point to 36 percent from the third quarter of 2018 to the third quarter of 2019.

Figure 2: Share of Conforming Conventional Home-Purchase Loans with LTV Ratio Above 95 Percent

Similarly, Figure 2 shows that the share of new conventional conforming 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 12 percent in the second quarter of 2019 and was the highest since 2008. The average LTV ratio for home-purchase loans in the third quarter of 2019 was 83 percent, up by one point from the same quarter of 2018.

Though both DTI and LTV standards have been relaxed in the past few years, there has been no change in credit score standards. During the third quarter of 2019, the average credit scores for the homebuyers with conventional conforming home-purchase loans rose by two points from the same quarter in 2018. 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 third quarter of 2019. 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.

Figure 3: Six Credit-Risk Attributes for Conforming Conventional Home-Purchase Loans: Q3 2019 Compared with 2001-2002

Figure 3 compares six indicators of underwriting and credit risk during a benchmark time period to present day for conventional conforming 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 third quarter of 2019, 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 69 percent and 8 percent, respectively, both higher than the benchmark level. The condo/co-op share was 3 percent higher than the benchmark level, while the investor-owned share was 21 percent lower than the benchmark level.

Mortgage rates started to decline in early 2019. Rates have dropped by about 1 percentage point in the third quarter of 2019 from the same quarter in 2018. The decline in share of loans with a DTI ratio above 45 percent reflects the improving affordability attributed to low mortgage interest rate throughout the year.

[1] 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.

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