I have been working in the consumer finance field since 1984 and was fortunate enough to be an original founder of Shamrock Financial. Today I’m the company’s Chief Executive Officer, which is a nice way of saying “I got here first.” My career is energized by Educating & Motivating my referral partners, staff, family and friends. I love what I do. The ability to repay: a fallen idol in mortgage lending.
August 13, 2010
The Big Man on Campus in mortgage underwriting is the borrowers “ability to repay“. The common thinking in the 2010 housing market is that the high level of defaults and foreclosure’s are the painful result of a decades worth of kicking the BMOC off campus. No doc, No income……no payment!
Few mortgage or real estate professionals would argue that making mortgage loans to unfit borrowers was like giving a driver’s license and a Mercedes to a class of forth graders. The facts, however, may tell a larger story.
A prospective borrowers “ability to repay” (debt-to-income ratio) is a tightly held underwriting criteria enforced strictly and legislated closely by government mortgage regulators and insurers. You make the mark and you get to progress along the underwriting obstacle course; miss the mark and you get removed. Typically, a borrower’s debt-to-income ratio needs to be 31% of the proposed mortgage payment and 43% of all credit obligations.
But the sneaky reality of someones “ability to repay” is that it’s merely a static snapshot in time. Today’s 28% ratio can be next months 56% ratio if the borrower accumulates additional debt, loses their job, takes a pay cut or drops an additional source of income. The silent homeowner obligations that fall outside of the “ability to repay” – taxes, water bills, car repairs, tuition, medical bills etc.- can also rock the “ability to repay” staging. So if “ability to repay” is so chaotic, so unreliable what could investors and regulators adopt as a better predictor of payment performance? Hmmm, easy: “The willingness to repay.”
What someone has the ability to do can differ wildly from what someone has the willingness to do. My two young daughters have the ability to be quiet on long drives but their willingness is another matter entirely. They have the ability to keep their rooms clean but not so much the willingness. Likewise, plenty of existing homeowners have the ability to repay, but absent a financial stake in the home – EQUITY – their willingness evaporates. Millions of homes in the US are now underwater. The greatest threat to the payment status of these mortgages is NOT someones ability to pay in as much as it’s their willingness to repay. Month after month we continue to see qualified borrowers leave their home. “Strategic Default” is the new rage in today’s mortgage industry. The key to reversing this trend is for FHA, Fannie, Freddie and additional funding sources to recognize that there is a huge potential to assist a troubled housing market by loosening up the unreliable “ability to repay” criteria in cases where a prospective borrowers “willingness to repay” is enhanced by down payment or equity position.
A buyer willing to put 20% down will out-perform a buyer putting 3% down no matter what the “ability to repay” tells you on the day they are underwritten. Same thing with a refinance candidate who has 20%-50% equity but a slightly higher debt ratio. In fact, I would advocate a return to, GASP…… no-income loans if the borrower is able to put down 25%. Especially in a bottomed-out market.
We need solutions and that means applying common sense. Until then, loan performance will court the “ability to repay” while a healthy market will lust for the “willingness to repay.”
Dean can be reached at dean.harrington@shamrockfinancial.com
Dean, very good take on the market
Great comments. Also with the advent of automated underwriting, we use what the computer tells us, thus taking away from the are of underwriting and common sense. What ever happened to the term disposable income?? Who’s to say that a 50% DTI is too high if you have a choice between two clients, one that has a family of 2 with $10000 gross income a month, vs. a family of four with $3000 gross income a month, which 50% deal would you take? VA believe it or not has it right where they look at disposable NET TAKE HOME PAY per dependent.
In the not so distant past, subprime clients with low LTV’s were a better risk than the high credit score, low down payment clients we see today. I say give the pen back to the underwriters and let them use some common sense.
It is interesting to read this article as someone new to the industry. At first glance a 3.5% down payment or no down payment sounds great. But as I read this article as well as the recent article on USA Today’s website, I am beginning to realize, just as in life, that there is an element of “some things are too good to be true.” Hopefully there will be changes in the near future that can help turn things around.
Great stuff here Dean.
Well said. Big down payments = vested interest in property and less likely to default.
Informative