Expiration of a Qualified Mortgage Rule May Hurt Housing Prices

(Bloomberg) -- Home prices may come under downward pressure should the Consumer Financial Protection Bureau allow the “GSE Patch” for Fannie Mae and Freddie Mac to expire in January 2021.

Home loans are granted a “qualified mortgage” (QM) designation should they meet certain criteria, one of which is that the debt-to-income (DTI) ratio of the borrower must be no higher than 43%. This QM designation for a loan is vital as it gives lenders protection from ability to repay litigation.

However, the government-sponsored enterprises (GSEs) -- Fannie and Freddie -- were granted an exception to this DTI rule, referred to as the “QM Patch” or “GSE Patch”, which allows them to produce loans with DTI above the 43% limit and still have them granted a QM label. This has incentivized originators of high-DTI loans to deliver them to the agencies.

High DTI loans have become a major component of the mortgage landscape as home prices continue to increase. GSE production of loans with DTI higher than 43% has risen steadily to 30% of the total last year from about 15% in 2015, according to a recent Wells Fargo report. In the first half of this year, that percentage has slowed to 28% ($98 billion) as lower mortgage rates have helped with affordability.

The CFPB estimates that in 2018 approximately 957,000 loans -- 16% of all closed-end, first-lien residential mortgage originations -- took advantage of the GSE Patch. Should the GSEs no longer be granted an exception for high-DTI loans, it’s likely borrowers would see a reduction in credit, which would put downward pressure on home prices, according to a recent Morgan Stanley report.

Such borrowers could migrate to Ginnie Mae, increasing its footprint in the high-DTI loan landscape, though the Federal Housing Administration in its latest annual report to Congress referred to its rising level of high-DTI loans as a “latent credit risk.” Ginnie Mae saw loans with 43% DTI or higher make up just shy of half its production last year. The proportion of borrowers with DTI ratios above 50% during its fiscal year 2018 was at 24.80% – an all-time high for this millennium.

As for the private market, it simply doesn’t have the capacity to handle a large influx of high-DTI borrowers in its current state, according to a Wells Fargo report. Without the FHA or the private market, would-be high-DTI borrowers in a world without the GSE Patch could find housing credit impossible to come by and remain renters.

January 2021 is still a long way off, and the CFPB may revise the QM definition before then to include a higher DTI threshold, leave it unchanged or, as various industry participants recommend, completely eliminate DTI ratio guidelines.

• Christopher Maloney is a market strategist and former portfolio manager who writes for Bloomberg. The observations he makes are his own and are not intended as investment advice

To contact the reporter on this story: Christopher Maloney in New York at cmaloney16@bloomberg.net

To contact the editors responsible for this story: Nikolaj Gammeltoft at ngammeltoft@bloomberg.net, Allan Lopez

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