Consumer Law

50% for Housing?

By Alan White

By Alan M. White

One question posed in the Federal Reserve's pending mortgage regulation is what percentage of income Americans should devote to housing. The question isn't posed in quite those terms, but those are the terms in which I think it should be asked. The subprime mortgage industry decided, sometime around 1994, that it was unreasonable to limit mortgage applicants to paying 41% of their income to their monthly mortgage payments (and all other installment debt.) Somehow the idea that 50% of gross income was a more reasonable limit gained currency, and some subprime lenders even went to 55% and 60% debt-to-income ("DTI") ratios. This was one of many ways in which mortgage underwriting standards, that previously had evolved through the long experience of the FHA program and Fannie and Freddie, were cast out the window.

It is true that the prior DTI caps, whether at 35% or 41%, excluded some consumers who could take on larger mortgages without defaulting. Even Fannie and Freddie have moved away from strict DTI caps because of their experience successfully making mortgages at higher ratios (albeit usually with other compensating factors.)

Increasing DTI ratios is a way to qualify more buyers for homes, or to qualify more existing homeowners to take out larger home equity loans. The industry (by which I mean not only mortgage lenders but also home builders and realtors) touts the loosening of underwriting standards as improving "affordability", by which they mean increasing the number of people who can buy homes. Of course, raising the DTI does not increase affordability at all, in the literal sense. It is simply a way of saying we will now devote a larger percentage of our incomes (which are not growing much) to housing. As Elizabeth Warren has pointed out, the fact that Americans are devoting a greater share of income to housing, along with the rising cost of health care, is a central feature of the declining living standard of the middle class. It is also one reason that home prices could increase faster than incomes.

The DTI ratio also does not account for taxes or any other expenses. As a result, a 50% DTI ratio is more like 70% of after-tax income for many middle income taxpayers. The industry has suggested that repayment ability should be presumed for consumers up to a 50% DTI. I have urged the Fed not to adopt any such safe harbors, on the grounds that such ratios lead to unreasonable foreclosure risk, especially for refinance mortgages to existing homeowners. I also think the housing payment ratio should be the subject of a national conversation. It is at the core of our sense that the welfare of ordinary Americans is no longer improving.

Full post as published by CL&P Blog on May 24, 2008 (boomark / email).