The Consumer Financial Protection Bureau (CFPB) recently announced that it will allow the so-called “GSE patch” to expire in January 2021.[1] This patch permits Government-Sponsored Entities Fannie Mae and Freddie Mac to buy loans even though the borrower’s debt-to-income (“DTI”) ratio exceeds the standard limit of 43%.[2]

The CFPB’s decision revives a long-standing debate about what constitutes a creditworthy loan. By eliminating the patch, the DTI ratio of 43% will become an absolute rule, making any loans with higher DTI’s ineligible for GSE funding.[3]

This type of bright-line rule—focused on a single component of a loan—has already drawn criticism as myopic.[4] Some have pointed out that, based on recent studies, DTI alone is a poor predictor for default of prime and near-prime loans.[5] For example, in each year since 2011, the 90-day delinquency rate for loans with DTI ratios over 45% has actually been lower than that for loans with DTI ratios between 30% and 45%.[6]

In fact, some studies indicate that adequate compensating factors can completely offset any minimal increase in risk associated with a higher DTI.[7] Yet, under this new rule, a borrower with a 44% DTI cannot qualify for a GSE loan, notwithstanding any number of other positive factors in the loan file.

It is entirely possible that this new decision could harm consumers, contrary to the CFPB’s mandate to protect them. Barring “high” DTI borrowers from accessing GSE loans could, at best, force such borrowers to obtain more expensive and riskier products, and at worst, preclude such borrowers from qualifying for any product at all.[8] Over the last six years, more than 10% of GSE-backed loans have relied on the patch.[9] Eliminating the patch is also likely to have a disproportionately adverse effect on minorities and others living in underserved communities.[10]

The creditworthiness of a loan, we firmly believe, must be evaluated by considering the loan as a whole. Simply isolating one aspect of the loan file such as DTI does not necessarily provide a thorough understanding of the risk profile. Instead, one typically must consider many characteristics beyond DTI–such as credit score and history, LTV and CLTV, asset and cash reserves, type and length of employment, and many more–to assess whether a loan should qualify for credit.[11]

Simply put, a loan typically cannot be considered a “bad” loan simply because of one feature. Instead, as some lawyers and courts have colorfully put it, each loan is a “snowflake” that must be considered independently and holistically on its own merits.

[1] See, for example, https://www.marketwatch.com/story/why-it-could-get-more-difficult-for-americans-to-get-approved-for-a-mortgage-2019-07-29.

[2] The other criteria for a Qualifying Mortgage (QM) include: (1) a lack of negative amortization, interest-only, or balloon features; (2) fully-documented income verification; (3) a total of points and fees less than 3 percent of the loan amount; and (4) a fully amortized payment schedule no longer than 30 years, with a fixed rate for at least five years, and all principal, interest, taxes, insurance, and other assessments included. See “Qualified Mortgage Definition for HUD-Insured and Guaranteed Single-Family Mortgages,” 78 Fed. Reg., 75215 (December 11, 2013); “Loan Guaranty: Ability-to-Repay Standards and Qualified Mortgage Definition under the Truth in Lending Act,” 79 Fed. Reg., 26620 (May 9, 2014); “Single-Family Housing Guaranteed Loan Program,” 81 Fed. Reg., 26461 (May 3, 2016).

[3] This rigid model stands in stark contrast to the FHA, VA, and USDA, which have no maximum DTI requirement. See https://www.urban.org/sites/default/files/publication/98949/qualified_mortgage_rule_0.pdf, at page 2.

[4] See, for example, https://www.responsiblelending.org/sites/default/files/nodes/files/research-publication/crl-a-smarter-qualified-mortgage-july2019.pdf.

[5] Id. at page 1; see also, e.g., Richard Green, “The Trouble with DTI as an Underwriting Variable—and as an Overlay,” Richard’s Real Estate and Urban Economics Blog, December 7, 2016, http://real-estate-and-urban.blogspot.com/2016/12/the-trouble-with-dti-as-underwriting.html.

[6] See https://www.urban.org/sites/default/files/publication/98949/qualified_mortgage_rule_0.pdf (see Table 2).

[7] See https://www.responsiblelending.org/sites/default/files/nodes/files/research-publication/crl-a-smarter-qualified-mortgage-july2019.pdf, at page 10 and footnote 33.

[8] Id. at page 7.

[9] https://www.urban.org/sites/default/files/publication/98949/qualified_mortgage_rule_0.pdf(see Table 1).

[10] https://www.corelogic.com/blog/2019/07/expiration-of-the-cfpbs-qualified-mortgage-gse-patch-part-3.aspx.

[11] https://www.urban.org/sites/default/files/publication/98949/qualified_mortgage_rule_0.pdf (see Table 2) (noting that credit scores and LTV ratios might predict default more accurately than DTI ratios).