Fannie Mae, the government-sponsored lending institution, is one of the biggest players in the U.S. mortgage market. That's why a recent announcement reported by The Washington Post is good news for some borrowers or current homeowners. Starting July 29, Fannie Mae will ease its mortgage application standards, allowing borrowers with a higher debt-to-income ratio to earn approval for a loan.
What is debt-to-income ratio?
The debt-to-income ratio is a metric commonly used as part of a loan application. It tabulates a person's total outstanding debt per month from other forms of credit and compares that to their monthly income. Fannie Mae will now approve borrowers with a DTI as high as 50, raising that ceiling from 45. This means that a borrower could be paying about half his or her monthly income just to debt payments without exclusion by Fannie Mae.
According to The Post, the DTI ceiling is "the No. 1 reason that mortgage applicants nationwide get rejected." With this change, Fannie Mae is most likely hoping to expand mortgage eligibility to younger homebuyers, who generally have lower incomes and higher debt loads. After all, student loans now constitute the largest share of consumer debt held in the U.S. besides housing debt, according to the Federal Reserve.
The National Association of Realtors also pointed out that the new DTI benchmark will change how monthly mortgage payments are determined. A maximum DTI of 50 brings Fannie Mae in line with the standards of other public lenders like Freddie Mac and the FHA. In fact, NAR noted that FHA loans may be approved to borrowers with a DTI over 50 in some cases. Private lending institutions are not allowed to approve any applicant with a DTI above 43.
Restrictions still apply
It's important to note that Fannie, Freddie and the FHA do not directly approve applications or extend loans. Rather, as the Post pointed out, they work to either guarantee mortgages against default or purchase large numbers of loans in what's known as securitization. Therefore, these new lending requirements are expected to open up the prospect of an affordable mortgage to more U.S. borrowers.
Still, applicants will need to pass muster in several other underwriting factors, some of which remain fairly strict. Fannie Mae's underwriting is mostly done through an algorithm, which accepts or rejects loans based on down payment amount, credit scores, loan-to-value ratio and many other metrics. The Post remarked that Fannie and Freddie each have higher credit score requirements than FHA loans - only borrowers with a FICO score in the mid-600s or higher can expect to be approved. The FHA, on the other hand, allows borrowers with FICO scores under 600, with the caveat that they must pay mortgage insurance, resulting in higher monthly payments.
All in all, Fannie Mae's underwriting change is good news for the average homeowner but doesn't mean mortgage applications will be a cakewalk from now on, either. Borrowers should work with a trusted lender to understand everything that goes into the application process.