The gatekeepers of the American mortgage market are increasingly backing loans to borrowers who have heavy debt loads, highlighting questions about mortgage risk as policy makers debate ways to change the system.
Almost 30% of loans that mortgage giants Fannie Mae and Freddie Mac packaged into bonds last year went to home buyers whose total debt payments amounted to more than 43% of their incomes, according to an analysis by industry research group Inside Mortgage Finance. The share has nearly doubled since 2015. Data on other government mortgage programs also show an increase.
The backing of these loans opens up a debate about the government’s role in the housing market. Some say cheap, federally backed financing has made credit available for millions of borrowers who otherwise might not have had a shot at homeownership. Others say that more-indebted borrowers are riskier, and that their purchases may be accentuating a rise in home prices that in many areas has outstripped median incomes.
Those contrasting views are spilling into the open as policy makers once again try to overhaul the housing-finance system. Mark Calabria, the recently confirmed head of the Federal Housing Finance Agency, which oversees Fannie and Freddie, said he plans to prioritize addressing this issue, though he hasn’t said specifically what he wants to do. A White House memo on housing-finance reform, released in March, also mentions it.
An obscure half-decade-old rule made these mortgages to buyers with high debt possible. The temporary provision expires at the beginning of 2021, or, should it happen first, when Fannie and Freddie revert to private control, following government sponsorship after the housing crisis.
The rule’s phaseout could upend the market by prohibiting Fannie and Freddie from buying loans with debt-to-income ratios above 43%, some in the industry warn.
“Policy makers have been backed into a corner with little choice but to finally decide what kinds of loans are safe enough to count as a qualified mortgage,” said Jim Parrott, a fellow at the Urban Institute, and former Obama administration housing adviser who is now an industry consultant.
When the Consumer Financial Protection Bureau introduced tighter mortgage-lending standards after the financial crisis, it deployed temporary measures to avoid cutting off some borrowers’ credit access. This exception was nicknamed the “qualified mortgage patch” and allowed Fannie and Freddie to purchase high debt-to-income mortgages.
Since then, Fannie and Freddie have loaded up on loans with debt-to-income ratios above 43%, the typical cutoff for mortgage loans. The Urban Institute, a think tank, estimated that an additional 3.3 million mortgages were originated between 2014 and 2018 because of the patch.
Fannie announced roughly two years ago that it would more freely guarantee mortgages with debt-to-income ratios of between 45% and 50%, though it has since tightened some standards. Freddie, which hasn’t announced changes, has seen its share of mortgages to such borrowers rise more slowly, and data suggest its share has been falling recently.
Chris Borg, a mortgage broker at Vantage Mortgage Group Inc. in Lake Oswego, Ore., said that in the past couple of years it has gotten easier for him to green light a high-debt mortgage when submitting applications to Fannie and Freddie for review. “Now, if I see someone with pretty good credit scores, I think it will go through,” he said.
Many have proposed various middle roads, such as measuring risk by other means. While borrowers with ratios above 45% had higher default rates than below-45% buyers before and during the financial crisis, high-debt borrowers have actually had lower default rates since 2011, according to the Urban Institute. This has led some housing experts to argue that the ratio isn’t an accurate measure of risk.
Not all high debt-to-income loans go to inherently riskier borrowers, lenders say. Borrowers often have other compensating factors, such as high credit scores or other income they aren’t counting, which make them safe bets for lenders.
When Rob Caress applied for a mortgage last fall, his wife Lourdes had just retired, which meant their debt amounted to 49% of their household income.
“I knew it was at our limit,” said Mr. Caress, who is self-employed selling printer and photocopier supplies. They were moving from a house just outside Portland, Ore., to a farther suburb where they would have more space.
But they had offsetting factors, including good credit, substantial savings and a big down payment on the property that made them a safe bet, according to Mr. Borg, their mortgage broker. They ended up getting a loan backed by Fannie Mae.
Still, some housing economists believe facilitating loans to borrowers who have a large proportion of debt has had deleterious effects on the broader housing market, such as by increasing demand to such an extent that it is artificially inflating home prices.
“We have a huge shortage of housing,” said Ed Pinto, co-director of the American Enterprise Institute’s Housing Center. “You can’t address that shortage by driving house prices up through leverage, which is what we’ve been doing.”
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