Rising consumer payments are squeezing homebuyers' budgets
There have been many changes to mortgage lending requirements over the years. One shift that long-time brokers will notice is an increase in the allowable back-end debt-to-income (DTI) ratio for borrowers.
While many traditional banks that kept loans in-house limited total DTI ratios to the low 40s, government-backed loans can see those ratios approach 50%, with FHA loans in the mid-50s.
One of the main reasons is that brokers and lenders have a wide range of tools to help determine if the borrower can handle a higher DTI ratio. However, one executive believes that it is a factor that brokers should be keeping an eye on when it comes to potential delinquencies.
Craig Riddell (pictured top), EVP at LoanLogics, said he’s seen things change over the years, and people need to keep in mind what a mid-50s DTI actually means for a borrower.
“For many years, roughly high-30s to low-40s would be a reasonable back-end debt ratio,” Riddell told Mortgage Professional America. “Because if you look at it from a net standpoint, you're 60% to 65%. Now, if you're allowing 56%, and somebody doesn't have a great savings pattern. Now you're at 70% of their net monthly, give or take.”
‘One speed bump away’
Riddell said while it makes sense that the credit box has expanded to help get more people into a home, it does make the household budget a little tighter with all the lines of credit.
“Lending has opened up the debt ratio that a consumer can pay,” Riddell said. “The credit box has begun to allow for it, because it just became the norm between student loans, credit cards, and car loans. If you wanted to get a consumer into a house, you had to kind of squeeze the back end a little wider.”
With FHA loans typically being low-down-payment mortgage products, the combination of limited equity at closing with a high DTI could present some problems a few years later if home values are slow to appreciate.
“It ends up being another challenge that, as a population, if you fast forward five or six years, do we have homeowners who are strapped, who can't maintain the properties that they bought because of other obligations that are out there?” Riddell said. “Then they end up defaulting on the credit cards first, then they default on the car, and then … that's the gloom and doom side.”
It’s that doom and gloom that has caused many potential homebuyers to stay out of the market. Riddell said if they feel like one negative event could drastically impact their financial situation, they’re less likely to want to make a major purchase.
“They're one speed bump away from what could be a bigger problem,” he said.” There’s a part of the population that, to their credit, thinks about, ‘What if I have a speed bump? What if I lose my job? Or what if this happens, then I'm not ready to buy because of that?’ You put all this together, and to me, I don't see it as a tangible blocker, because I don't think many consumers even know that they could go close to 50%.
“But I think emotionally, they don't think they're ready, and maybe that's healthy, because they're probably financially not. If you feel that way, then you're not. How you feel is probably close to the reality of the situation.”
Balancing the emotional weight
For that first-time buyer who has closed on their new house, they often deal with conflicting emotions. They’re elated to finally own a home, but they may be stressed about what that new payment does to their monthly budget. He also warns that the budget may be constrained further by new-home furnishings that is often financed on credit cards.
“I might be able to get qualified for the mortgage for the house in the neighborhood that I would be interested in,” Riddell said. “I didn't know that, because I didn't think that a bank would let me qualify with this math. If I buy a house, then I have to furnish it, and then you start to roll up credit card debts.
“If you monitor somebody's credit card expenditures the 18 months after they buy, in particular, their first home, it rises. You’ve got to buy things, but then they can't pay them off as quickly as they thought. And now, two years after buying, they got $10,000 worth of expenses that they thought they would chip away at, and they can't, and then they get burdened.”
Riddell said this is all part of the math that brokers have to be upfront with customers about. They need to understand not only what a new payment will do to their budget, but how additional expenditures might strain it further. It’s why being able to qualify for a mortgage doesn’t mean it’s the right decision.
“I think there's the melancholy feeling of either I'm never going to get it, or if I do, what weight is it?” he said. “I won't enjoy the house if I can't sleep well. I’ve got 16 more days till that mortgage payment is due. I'd rather not deal with that stressor, so I'm going to stay where I am.”
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