It has been a few days now since the agencies released the guidance on nontraditional mortgage products. I had an opportunity to talk to or review the opinions of a number of Wall Street analysts. Their conclusions are diametrically different from mine. Since they are all high paying credentialed analysts, I have no choice but to review my findings and see where I may be wrong.
I opined that switching back from a FICO based to a ability-to-pay underwriting standard is alone a monumental change. Compounding that with using fully indexed rate and fully amortized repayment, this will close the door on the irresponsible practices of the last 3 years.
Here is an illustration:
mortgages-loans-calculators.com
(click on “View Report”)
This is for a $100,000 loan, comparing Fixed, Fully Amortized ARM and IO ARM. The initial payment is $615, $536 and $416 respectively. If I use a middle of the road front DTI income of 35%, the pre-guidance income required to qualify for this $100,000 loan would be $1,757, $1,531 and $1,188 for each of the programs.
(Explanation of DTI)
mortgageunderwriters.com
Post guidance, at fully indexed and fully amortized payments, the income required would be $1,757 regardless of the program the borrower chooses. In other words, a borrower using the IO ARM program would have to show $569 (or 47.9%) increase in income to qualify for the same $100,000 loan.
“Benign” was the word I heard repeatedly, in reaction to the guidance. I don’t understand how a 47.9% increase can be considered benign. What am I missing?
The example above is a standard IO ARM with no teaser nor other exotic features. I opine that the majority of the borrowers today choose ARM, especially IO ARM for the purpose of qualifying. There is no chance that this group of borrowers could qualify using the fully amortized and fully indexed payments to calculate DTI ratios.
A lender can choose to use mitigating factors, namely higher FICO, lower LTV and DTI ratios. Lets look at each of these factors:
FICO – is it likely that the nations credit score can improve in the near future, or would higher FICO score simply eliminates a segment of borrowers?
nationalscoreindex.com
LTV – during the last couple of years, the V of LTV has been appreciating across the nation. Now that is over, a lower LTV requires a lower L. Is it reasonable to expect home purchasers now to increase their downpayment amount?
DTI – discussed above, the D part of DTI is expected to rise substantially for any non-fully indexed nor amortized products. Is it reasonable to expect the income of the borrowers to rise fast enough to make up the difference?
Of course, the guidance is indeed BENIGN if buyers of mortgages, be it whole loans or securitizations, continue to buy. Furthermore, if defaults and loss severity stay at manageable levels, then the guidance is just that, guidance. |
