Sunday, November 21, 2010

Debt-to-Income ratios get tougher by FANNIE MAE

At the beginning of our recent class, entitled Mortgage Mania at Bethpage FCU, I was asked a question, which was more like a statement, inquiring if a lower Loan to Value (L/T) ratio (more money down) was a key predictor of default risk.

IN ENGLISH - If a borrower puts down more money (has more equity) shouldn't that imply they won't default? I took issue with this statement by saying that I believe that back-end Debt to Income (DTI) ratio mattered a hell of a lot more. My rationale was that even if you had a lot of skin in the game, your inability to make your mortgage payments trumped your desire to make your mortgage payments. The student took issue with my sentiment throughout the class thereafter by defending his position.

It’s true that both L/T ratio and DTI ratio are relevant and evaluated by lenders in making a loan. Yet, my message was that DTI ratio is much more important in making the determination to provide funding. 

It turns out that FANNIE MAE agrees. They just changed, effective December 13, 2010, their requirements with respect to each of the above discussed ratios. Specifically, maximum DTI ratios for a conventional mortgage change from 55% to 45% under the new guidelines. Additionally, borrowers can now utilize gifts and grants to satisfy their minimum down payment, which impacts the L/T ratio. To read a great New York Times article that summarizes these changes, click here. Remember, that FANNIE MAE sets the standards for the rest of the industry because they are the largest secondary market purchaser, so this will likely become the standard.

The takeaway for students reading this blog is that a lender cares more about your ability to pay (how much money you have left at the end of the month after paying your other bills) as opposed to your desire to pay (how much equity you have to lose if you don't pay).

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