- A mortgage rule change announced in July 2017 could make home loans easier to obtain, particularly for borrowers with a lot of debt relative to their income.
- The change made by Fannie Mae will increase the allowable debt-to-income (DTI) ratio limit from 45% to 50% of gross income.
- This adjustment applies to conventional loans, which do not receive government backing. Government mortgage programs, such as FHA, have their own rules for debt-to-income ratios and other criteria.
- But just because you could spend half of your pre-tax income on your mortgage and other debt payments doesn’t mean that you should.
Fannie Mae, one of the two government-sponsored enterprises that buy and sell home loans, recently announced a mortgage rule change that could extend financing to a larger pool of borrowers. The “GSE” will soon allow for higher debt-to-income ratio limits. The change is expected to take effect in July 2017, and it could increase access to mortgage financing throughout 2017 and into 2008.
How Fannie Mae and Freddie Mac Rules Affect the Mortgage Market
Fannie Mae and Freddie Mac buy mortgages from lenders in the primary market and then sell them off to investors in the form of mortgage-backed securities. The two corporations have specific guidelines and criteria for the loans they are able to purchase, and these are passed down from the Federal Housing Finance Agency (FHFA).
For Example, Fannie Mae and Freddie Mac have size limits for the mortgage loans that they are able to buy, and these are referred to as conforming loan limits.
The GSEs also have specific requirements for debt-to-income ratios, and we will talk about those in a moment.
The important thing for borrowers to understand is that the guidelines used by Freddie and Fannie also affect borrowers in the primary mortgage market. So if you want to use a “mainstream” conventional home loan, you have to meet the requirements set forth by Freddie Mac and Fannie Mae.
Rule Change: Higher Debt-to-Income Ratios Allowed in 2017
How much combined recurring debt do you have right now, relative to your income?
This is one of the first questions mortgage lenders will have when you apply for a home loan. They refer to it as the debt-to-income ratio, or DTI for short. This percentage is one of the most important qualifying criteria for mortgage borrowers.
In short, if you carry too much debt relative to your monthly pre-tax income, you could have trouble qualifying for a mortgage loan.
There are two main types of DTI ratios – one that only uses housing-related debt, and one that takes all recurring debts into account. The mortgage rule change being introduced in 2017 relates to the total or “back-end” debt to income ratio.
In the past, Fannie Mae has set a total DTI limit at 45%. That meant that a borrower’s total debt (including the mortgage loan, car payments, credit cards, etc.) could not exceed 45% of his or her gross monthly income. But according to this mortgage rule change, which was announced earlier this month, they will raise that limit to 50% later in July 2017.
A Common Reason for Loan Denial
Analysis conducted by the Federal Reserve and other organizations has shown that excessive debt leads to more mortgage loan denials than any other single factor. That’s why this policy change is a big deal for borrowers.
When a person applies for a home loan, lenders must evaluate their financial situation to make sure they’re not taking on too much debt. After all, that could reduce a person’s ability to meet their monthly mortgage payments.
Analysts with Fannie Mae reviewed years worth of data and determined that there are many potential borrowers with debt-to-income ratios in the 45% to 50% range who are otherwise well qualified for a home loan. They are introducing this mortgage rule change to better serve that audience — and to boost their earnings, of course.
Different Rules for Government-Backed Programs
Borrowers should know that there are different debt limits for different types of mortgage loans. The Fannie Mae rule change mentioned above primarily applies to conventional home loans that are not insured or guaranteed by the federal government.
Federal Housing Administration (FHA) home loans, which do receive federal backing, have their own set of standards for debt ratios, credit scores, etc. But conventional loans represent the largest slice of the mortgage market, so this change could impact a lot of borrowers in 2017 and 2018.
The Federal Housing Administration sets the bar at 43% for total debt-to-income ratio, but they also allow for compensating factors. Borrowers with excellent credit and a history of managing similar mortgage payments could still qualify for an FHA loan, even if their DTI is higher than 43%.
Brandon Cornett
Brandon Cornett is a veteran real estate market analyst, reporter, and creator of the Home Buying Institute. He has been covering the U.S. real estate market for more than 15 years. About the author