A decade ago, Congress enacted the Dodd-Frank Wall Street Reform and Consumer Protection Act, ushering in the Ability-to-Repay/Qualified Mortgage era of mortgage lending. The ATR rule, as defined by the Consumer Financial Protection Bureau, requires a reasonable and good faith determination by mortgage lenders that a borrower is able to pay back the loan.
But what began as a way to ensure the financial crisis never happens again has instead created a new set of challenges for would-be homebuyers, especially when it comes to homeownership opportunities for minorities.
Dodd-Frank was born out of the 2008 financial crisis and was a landmark piece of legislation to try and prevent the kind of anything-goes lending that characterized that time period. Dodd-Frank also created the CFPB, which is charged with protecting borrowers from financial institutions.
The history
The introduction of the Ability-to-Repay rule was part of the concept of a Qualified Mortgage. In order to be classified as a Qualified Mortgage, a loan has to adhere to certain requirements, which preclude excess upfront points and fees, interest-only periods and balloon payments. There’s also one of the most highly debated features – the debt-to-income ratio. For Qualified Mortgages, the acceptable DTI ratio sits at 43%, meaning a borrower’s monthly debt payments divided by their gross monthly income cannot exceed 43%.
The CFPB states on its website that “evidence from studies of mortgage loans suggest that borrowers with a higher debt-to-income ratio are more likely to run into trouble making monthly payments.”
However, not everyone in the industry agrees on the effectiveness of the DTI as a gauge of risk. In September 2019, a coalition of some of the nation’s largest lenders and trade associations, including Bank of America, Quicken Loans, Wells Fargo, Caliber Home Loans, the Mortgage Bankers Association, the American Bankers Association and the National Fair Housing Alliance, called on the CFPB to do away with the QM rule’s DTI requirement.
Apparently, that message resonated at the CFPB, since at the start of this year, CFPB Director Kathy Kraninger said the bureau decided to propose an amendment to the QM Rule that would “move away” from DTI as a factor in mortgage underwriting. In June, the bureau announced changes to the QM classification, looking to amend the Qualified Mortgage definition in Regulation Z to replace the DTI limit with a price-based approach.
A huge pain point for the industry has always been that loans sold to Fannie Mae or Freddie Mac can exceed the 43% DTI ratio and still be considered a Qualified Mortgage, a rule known as the GSE Patch. The GSE Patch is set to expire in 2021.
The move away from the QM rule, while advocated for by a number of the nation’s largest lenders and housing trade groups, doesn’t come without some pushback. The scars from the financial crisis are still very raw, and anything that appears like it could be a return to the financial crisis starts sounding the alarms inside and outside the industry.
The impact to minority borrowers
To the people who are leery about the DTI eliminations, Susan Stewart, chairman-elect of the Mortgage Bankers Association and CEO of SWBC Mortgage, said that these changes don’t remove the protections that have been put in place since the 2008 financial crisis that harmed so many people.
Instead, Stewart, who is also the chairman of MBA’s Diversity and Inclusion Committee, said that it’s really important to put these changes in the context that the DTI ratio is one factor in getting a mortgage.
“It’s very hard to narrow down the reasons why someone is not getting a home based on one single factor. It’s just not a one-dimensional decision,” she said. “A loan is like a person, there are lots of different things that you look at and lots of risk layers that you take into consideration.”
On the other hand, what having a DTI standard that is set in stone does do is disproportionately impact minorities, Stewart said.
And Stewart isn’t alone in this thinking. In a comment letter to the CFPB on the QM rule, the Urban Institute explained how a 45% DTI cap disproportionately affects minorities and first-time homebuyers in their ability to obtain mortgage credit.
According to the report, “as a single-dimensional variable, the DTI ratio by itself does not capture credit risk comprehensively.”
In fact, the Urban Institute explained how many high-DTI mortgages default at lower rates than low-DTI mortgages, meaning high-DTI mortgages are less risky.
In the government channel, which includes FHA, U.S. Department of Veterans Affairs and U.S. Department of Agriculture loans and serves a larger share of minorities than the GSE or the non-GSE conventional channels, the report stated that 43.3% of all government loans made to Black borrowers in 2018 had DTI ratios over 45%. This share sat at 46.8% for Hispanic borrowers and 47.9% for Asian borrowers.
The Urban Institute also found that a loan to a Black borrower was 18% more likely to be a high-DTI loan than the overall government loan universe. Additionally, it said that a loan to a Hispanic borrower was 27% more likely to be a high-DTI loan than the overall government loan universe.
While the findings were less dramatic in the GSE channel and the private channel, they still showed minority borrowers’ increased dependence on high-DTI lending relative to white borrowers.
Since minority borrowers are significantly more dependent on high-DTI lending, having a 43% DTI cap disproportionately affects minorities in their ability to obtain mortgage credit.
The Urban Institute chose to use a 45% DTI cutoff instead of a 43% cutoff to emphasize that eliminating the QM patch and relaxing the DTI cap from 43% to 45% would be a marginal change at best.
Stewart explained that with a strict DTI requirement, lenders aren’t able to look at any other factors. “Perhaps they’ve been paying rent that is high, maybe even higher than their house payments would be, and they’ve paid it beautifully and they’ve been able to maintain their credit, you couldn’t even consider that,” she said.
As lenders, she said, “We’re supposed to say, ‘Okay this borrower doesn’t have that much information, so we’re just not going to make that loan.’ That’s what they call a thin borrower.”
“When in reality, you can get more information because everybody has a financial picture, and maybe you have to ask for a little more information and maybe you have to check out some other areas of things they were paying for,” she said. “But you can build a good loan, and you can show responsible management of credit, and then you can help these people become a homeowner.”
Stewart added that although eliminating the DTI is a good step, there’s a lot of additional things that have to happen for the industry to start to solve the problem of low levels of minority homeownership.
“There’s a lot of things that we can do, and a lot of them are going to require policy changes and extra work that we’re all thinking about and working towards so that we can say, ‘look we have a way that we can really start to help an entire generation of minorities start to build wealth and get some of the advantages of homeownership that you don’t get if you never have access to credit to buy a home,’” she said.
