On July 29, Fannie Mae will activate an update to “Desktop Underwriter,” the software that analyzes borrower applications and grants approval — “DU” in shorthand spoken with reverence or disgust throughout the industry. This update will make it easier for us to approve loans.
You can hear the music already. “Easier? These idiots should be folded up. Get government out of lending.” Even those not quite so opposed to government are uneasy that Fannie (and Freddie) are still wards of the U.S. Treasury and taxpayer, have no capital, no cushion for loss, have guaranteed $6 trillion in loans already, and nobody in either political party knows what to do with them. And the housing market and entire U.S. economy depend on them.
Deep breath, please.
The most important specific easing will be an expansion of the maximum debt-to-income ratio (DTI) from 45 percent to 50 percent. That is, gross monthly pre-tax income times 50 percent will be the new maximum for monthly debt payments — house, car, student loan, credit cards, whatever.
Half of pre-tax? Are you nuts?
Not yet. My script to clients has been the same for a very long time. When prospective homebuyers call to ask how much they’ll be approved for, I’ve always responded with a dry chuckle: “We can loan you enough money to ruin you. Let’s begin with another approach: Take a financial inventory, talk about your resources and your hopes, and see what makes sense?”
We did discover in the bubble that a significant although small fraction of Americans will borrow enough money to ruin themselves — if we’ll let them.
Never did make sense to me. Why go into hopeless hock to buy a dream home when, in six months, you’ll be dreaming about the house after the foreclosure?
That group is an exception. We must remain on guard not to make ruinous loans, but the far greater fraction of Americans, hugely greater, sets its own household limit on payments a lot lower than Fannie’s maximum.
If the vast majority of borrowers does not want a suicidal limit, what’s the big deal?
These two very common situations:
1. You have a good job with a salary, but your husband has just taken a job as a contractor, paid on a 1099, not W-2. He got a big raise, the contract payments are monthly and fixed and open-ended, just no “employee” status, no benefits, no paycheck witholdings. Your husband now and for the next two years in Fannie’s eyes will have no income. If you’re going to buy a new house, you’ll have to qualify on your own. Your true, family DTI will be only 20 percent, but on DU it’s 47 percent. Now you’ll qualify.
2. You own a house and you want to buy a new one. The payment on the new house will be only 28 percent DTI, but inclusive of your current house payment, 49 percent. You could rent your current house and qualify under old rules, but an irritable tenant makes it harder to sell the house. And to offset the mortgage payment the new lease must be for one year. Now, no problem — a deadly DTI on DU, but all-OK as soon as you sell, and presuming that you have savings to cover two payments for a while.
A higher allowable DTI helps us with two intractable after-effects of the bubble. The most-abused loans were “stated income,” the legendary massage therapist who claimed to make $150,000 per year. The result of slamming the door on that elastic but bad lending: We have no way to deal with unusual incomes and or families with very large savings and investments but little income on paper. A wider DTI helps.
As do these elements of safety: to get to 50 percent DTI you must have very high credit scores, and cash reserves after closing. No free lunch.
Lou Barnes is a mortgage broker based in Boulder, Colorado. He can be reached at lbarnes@pmglending.com.
