Why are banks still making loans of 45% to 50% of Gross income?

Asked by Aj, Central Business District, Newark, NJ Mon Mar 10, 2008

What ever happened to the 28/36 debt to income ratio? Many first time buyers don't know the true cost of home ownership, especially if they have been renters all their life. There are all the little extras that you need to purchase for your new home that start to put a big dent in your budget. Banks used to follow the guideline of up to 28% of gross monthly income for mortgage and tax payment allowance and 36% of gross income for all of a borrowers debt, including auto loans, student loans, credit card debt, etc. Now many new home builders, mortgage brokers and even many banks are approving mortgage debt as high as 45% of gross income or even higher because they don't have to carry the risky loan. They can quickly turn around and sell it off so if the borrower gets in trouble and can not make payments on the loan, the lender is not affected by them.

Until the government regulators address this huge issue, the real estate mess will only get worse!

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15
Jim Walker, Agent, Carmichael, CA
Tue Mar 11, 2008
BEST ANSWER
I was a loan processor in the 1980's and early 1990's when the DTI ratios were strictly observed.

Well, not strictly. The loan processor could write a narrative submission letter to the underwriter that made the case why the DTI ratio could raised by a few points. The mitigating factors would include: 1) substantial liquid assets in reserve accumulated through earnings and savings. (. 2 High probability of future earning increases. 3) extraordinarily low basic living expenses. 4) Historically high savings rate by the buyer

Evidence substantiating the mitigating circumstances had to be documented in the file. Some people are able to pay 45% of their income towards housing. Those exceptions should not be punished because they don't fit a cookie cutter mold. Paradoxically these anomalies tend to be at the lower and the higher ends of the income scale, not so much in the middle. They also tend to be people with extraordinarily good credit records.
2 votes
Corey Grushin, Agent, East Brunswick, NJ
Tue Mar 11, 2008
AJ good question. First know the 28/36 is a suggested standard to follow for manually underwritten conventional loans. FHA usually follows 29/41 ratios for manually underwritten loans. Today most loans are underwritten using either Fannie Mae or Freddie Macs underwriting computer system (automated underwriting). The system uses credit report/score profiling along with debt ratios and monetary reserves on the application. If the Automated Underwriter approves the loan, then the bank will usually issue a commitment to lend. Automated underwriter has removed a lot of the human aspect on the loan approval process but not all of it, because the human underwriter has the final say. Also banks or mortgage companies who sell off the loans are subject to buying them back if the loan goes bad within the first 12, so they do have a fiduciary responsibility to approve good loans.
3 votes
Victor Kamin…, Agent, Edison, NJ
Thu Aug 7, 2008
Education of mortgage reps and realtors about topics like how to do their jobs would be greatly beneficial to this industry and restoring the once looked upon professional industry as that once again instead of as AJ puts it, Snake Oil Salesmen.

Mandatory Education requirements for real estate and mortgage industries is seriously lacking.

Keep in mind I'm not blaming mortgage reps or realtors for this mess, everyone played a part. I'd just like to suggest a solution to lessen the odds of it happening again.

It is a shame but the state depends on the real estate and mortgage brokers to educate their agents on the basics and themselves only require courses on how not to break laws.

This answer by one of the bloggers below shows how dependant people in the industry are on the automated systems to do the work but these systems only search for ANY loan which the applicant may qualify for without regard for the original intended purpose of the loans.

The models for evaluating loans are very sophisticated now. They must have data on full documentation that it works at this level. I can see for stated income that this may not be a good idea....

--
Victor Kaminski
Broker of Record
Marivic GMAC Real Estate
2056A Lincoln Hwy. (Rt.27)
Edison, NJ 08817-3330
Office: 732-650-9911 Ext.302
Cellular: 908-884-5757
Toll Free: 1-866-745-GMAC(4622) Ext.302
http://www.MarivicRealty.com
http://www.realrep.com/
(MIDDLESEX MLS SEARCH) http://search.victor.msx.mlxchange.com/
(GSMLS SEARCH) http://www.gsmls.com/
(Monmouth/Ocean MLS) http://monmouthoceanmls.com/victor
http://www.homes.com/Agent/4243382/victorkaminski
http://www.trulia.com/voices/profile/Real_Estate_Pro-Edison-…
http://www.city-data.com/forum/members/victorkaminski-211209.html
http://www.realrep.com/Listing/DefaultListingSummary.aspx?Sh…
http://www.city-data.com/forum/3305497-post16.html
http://www.trulia.com/voices/Home_Buying/I_m_thinking_of_pur…
http://nls.point2.com/members/US/New-Jersey/Edison/Victor-Ka…
1 vote
Victor Kamin…, Agent, Edison, NJ
Thu Aug 7, 2008
We'll the DTI ratios aren't normally quite that high, I'm sure its out there but remember as well that for variable rate loans as the interest rates fluxuate so does the DTI.

I really don't see too many this high except maybe with the cases of many of the subprime loans which were being used for the wrong reason. With the passing of the new bill for mortgage relief for home owners in trouble of foreclosure and to encourage first time home buyers to purchase which was recently passed by president bush there were a few earmarks forced in there by the democrats.

Bush, knocked down the passing of this bill twice before but the dems refused to remove their earmarks and the president felt it necessary to pass this bill. Unfortunately the earmarks put in place by the dems called for allowing the mortgage companies that were giving out these bad loans in the first place room to start doing it again, so they are! I'm seeing it already, I just threw out a bunch of fliers a mortgage rep just dropped off at my office because he's pushing these ridiculous loans as his main product.

That's it pretty much in a nutshell...

Being a real estate professional I'd have to disagree with AJ in part but it wouldn't be a first time, as far as the professional real estate agents driving up home prices artificially above affordable levels, how would that be done?

What drives prices up is the market and the ability for people to afford more of a house through loans which are very good for the purpose they were created however are being used incorrectly in order for people to be able to purchase too much house then they can really afford by using loans which were not meant for the purpose they are being used.

I'm sure there are some real estate agents pushing these loans, a little knowledge can be dangerous and there are quite a few agents out there that really don't fully understand their job function fully.

PASS CONTINUING EDUCATION FOR REALTORS AND MORTGAGE REPS, actually the scary part mortgage reps don't have an education requirement to get a license, not even a pre-licensure course in New Jersey and that is scary, not even finger printing or background checks. All it takes is a one page application and a check for $100 to get licensed under a mortgage broker.

Anyway... There is plenty of blame to go around, the mortgage reps are huge offenders matching people up with the wrong products, either for not understanding the products fully which they are selling or by doing so just for the quick buck OR because the purchaser understood but REALLY REALLY wanted the house and was irresponsible in their way about obtaining it.

The first 3 replies to this answer were pretty good too.

AJ -
"Do all those sophisticated model take into account a borrowers age, future obligations such as, retirement income needs, health care costs later in life, college tuition and wedding expenses for any children? I don't think so."

AJ why should they, take a little responsibility for your own actions. Is the bank suppose to calculate your loan based on the assumptions of a predetermined figure which you must be able to save for retirement, getting married (many people don't), having kids (many people don't) and also taking into consideration costs of any hobbies or other expenses you have first? Sounds like you may be one of those folks that would like the government running your life, planning your future for you. Not the kind of America I want to live in!

--
Victor Kaminski
Broker of Record
Marivic GMAC Real Estate
2056A Lincoln Hwy. (Rt.27)
Edison, NJ 08817-3330
Office: 732-650-9911 Ext.302
Cellular: 908-884-5757
Toll Free: 1-866-745-GMAC(4622) Ext.302
http://www.MarivicRealty.com
http://www.realrep.com/
(MIDDLESEX MLS SEARCH) http://search.victor.msx.mlxchange.com/
(GSMLS SEARCH) http://www.gsmls.com/
(Monmouth/Ocean MLS) http://monmouthoceanmls.com/victor
http://www.homes.com/Agent/4243382/victorkaminski
http://www.trulia.com/voices/profile/Real_Estate_Pro-Edison-…
http://www.city-data.com/forum/members/victorkaminski-211209.html
http://www.realrep.com/Listing/DefaultListingSummary.aspx?Sh…
http://www.city-data.com/forum/3305497-post16.html
http://www.trulia.com/voices/Home_Buying/I_m_thinking_of_pur…
http://nls.point2.com/members/US/New-Jersey/Edison/Victor-Ka…
1 vote
Ron Thomas, Agent, Fresno, CA
Thu Aug 11, 2011
Boy, if there ever was a question that was out of date, ( 3 years + ! )

this is it.
0 votes
, ,
Thu Aug 11, 2011
The primary problem never was with 45 to 50% back end loans that were done based on verified income and employment with 3-20% down payments. The problem centered mostly on 100% financed SISAs (stated income and stated assets) and NINA (no income and no assets) deals. When you have no skin in the game, you have no skin to loose.
0 votes
, ,
Thu Aug 11, 2011
My two cents, Traditional DTI of 28/36 would not make "american home ownership" dream true!!!! :). The banks are making loans up to 45 DTI because there are enough players in the game to sell the money (supply - fnma, fhlmc, gnma a.k.a agencies) and buy the money (demand - wall street investors) with that ratio for the borrower using their FICO, income and assets financials, smart underwriting guidelines and other compensating factors. The loan approval is issued by these agencies AUS - automated underwriting system. I strongly believe all parties involved in the cycle is somewhat aware that 45 DTI may not be right for every borrower however they believe as long as AUS says you can do it they make assumption on borrowers to have that money (loan). I have seen typical portfolio lender (use they own money to fund the loan, most of the time they do not sell loans out to investors for servicing) do not go DTI over 35/45. Bottom-line the basic mortgage economics of supply-demand rule is working at 45 DTI. So they and we are doing it. Is it in truly equilibrium????? Wish I know.
Web Reference:  http://kjpfin.com
0 votes
Victor Kamin…, Agent, Edison, NJ
Mon Jun 8, 2009
Jim I agree with you that the higher ups in the banking industry had their part but mainly because they were forced to by congress...

Due to democrat ruled Congress decisions forcing banks to write more and more so called "affordable mortgages" which they knew would end up in default (despite cries from the oversight committees for more oversight and warnings against continued behavior like this) but Barney Frank, Frank Raines and other crooked elected officials making decisions based on who lined their pockets with gold and favors thru special interest groups like acorn and others and playing both sides with the banks Fannie/Indy/Freddie Mac is pretty much what contributed in a HUGE way to the current economic situation.

I don't get your reasoning behind put down all the "other" realtors that were working during the past 3 years (dedicated career agents) while you "sat on the sidelines" during the busy market period as playing the part that decides how lenders determine their lending standards???

You mentioned several different unrelated but wildly popular hated topics, (banking system management bonuses and Ponzi schemes) trying to tie realtors (except yourself "sitting on the sidelines") and mortgage reps being the ones to blame for banks lending standards?

This is beginning to sound like an Obama speech, exciting the crowds using off topic popular key phrases from left field and then put blame on others. This is pandering to the ignorant but can't tell why, maybe I missed something?

(Why exactly were you not working "sitting on the sidelines", I think I missed that part?)

By the way AJ most banks I've been dealing with currently are using 35 to 45% MAX depending on credit score being accepted. Some are considering people with higher DTI ratios but I'm not seeing them actually getting funded.

Don't worry, as interest rates rise and our country gets deeper into debt we'll be back to a 28/36 preferred ratio. Only time will tell...
0 votes
Ed Fallon, M…, , West Chester, PA
Sat Jun 6, 2009
The lender is very much affected by poor loan performance, even if they sell it off. If the portfolio of loans that a lender sells to another lender has a high default rate and poor overall performance, they will probably be cut off by that lender. And more and more legislation shows that the original broker or correspondent lender will bear some financial responsibility for loans that go bad. Lenders want to make loans to people that are going to repay the debt. The debt to income ratio is only one factor that is considered in the algorithms used by the automated underwriting software, and a weakness in one area may be compensated by a strength in another.
0 votes
Jim Walker, Agent, Carmichael, CA
Thu Aug 7, 2008
Victor suggested education for the loan officers and agents. -- Who can argue with that?

Well I think the management circles at Bear Stearns, Countrywide, IndyMac, Freddie Mac, and Fannie Mae all had heaps and steaming piles of education. It was not a lack of education that inspired these financial geniuses to transform the world financial system into a massive Ponzi scheme. Nope these good old boys have degrees and masters of business administration and finance degrees.

Even our president who is portrayed by the comedians as a goofy hydroencephalitic lightweight graduated from Harvard AND Yale ! - Both !

When the folks who ran the banks and the country were dictating that snake oil is what every consumer should have, because it was good for corporate profits and share prices and especially management bonuses ! ; the Realtors and mortgage reps either "played their part" or found a different line of work.

- Not everybody could stay on the sidelines for 3 years the way I did.
0 votes
Aj, Both Buyer And Seller, Central Business District, Newark, NJ
Sun Aug 3, 2008
Thanks to all those that took time to answer, especially to Jim Walker and Corey Grushin. I agree with Jim that for those buyers (like Jemmy Kan), who can afford to or discipline themselves to pay a greater amount of their income towards mortgage payments "should not be punished because they don't fit a cookie cutter mold." However, they are exceptions and not the norm.

As far as the banks fiduciary responsibility to make good loans were obviously circumvented by making loans with low initial payments that would last beyond the bank's contractual obligation to take back the loan. Once the contractual obligation is over, the payments jumped to levels that borrowers could no longer afford and the loans become non-performing.

Obviously the sophisticated loan evaluation models and using credit scores to approve loans do not work. A great credit score does not measure the ability of a borrower to make a required payment for the loan. A low income family may build up a great credit score, but their ability to make the mortgage payment is still limited by the income they generate. Conversely, a high income family may have a garnered a lower credit score due to a few late payments, etc. but they still have the income to be able to make bigger mortgage payments.

I am not in favor of government regulations either, however, real estate industry has allowed unscrupulous brokers, agent, appraisers and other so called professionals to drive home prices artificially above affordable levels. And now legitimate, financially sound buyers like me can not purchase a home without mortgaging our future.

Do all those sophisticated model take into account a borrowers age, future obligations such as, retirement income needs, health care costs later in life, college tuition and wedding expenses for any children? I don't think so.

To me the words "sophisticated" and "professional" are sounding more and more like synonyms for "snake oil salesman".
0 votes
Debt Free Da…, , 85260
Tue Mar 18, 2008
The models for evaluating loans are very sophisticated now. They must have data on full documentation that it works at this level. I can see for stated income that this may not be a good idea....
Web Reference:  http://getprequalified.com
0 votes
Pam Winterba…, Agent, Danville, VA
Mon Mar 17, 2008
Aj....

Another option might be a FHA loan as they are very liberal on their debt ratio's and credit scores.
0 votes
Deborah Madey, Agent, Brick, NJ
Mon Mar 17, 2008
Mortgage backed securities provided for many in the country to beocme homeowners who might not otherwise have been able to do so. Selling the mortgages provides the mortgage banks new money to lend. It's up to buyers of these mortgage backed secruities to scrutinize what they buy. If the mortgage banks cannot sell the loans, they will alter the lending standards. It doesn't need government regulation.
0 votes
Jemmy Kan, Home Buyer, Somerset, NJ
Mon Mar 17, 2008
Very true, and I used more than 45% of my income to pay my mortgage and my 3br townhouse is now paid off. I am looking to borrow ARM so that I can take some good advantage of the first few years of super low mortgage rate, and I would pay much more than minimum monthly payment plus as much as I could on the mortgage money. Why? puting money in CD's these days is very little interest rate.
0 votes
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