Mortgage qualification guidelines are getting tighter again as Fannie Mae (along with FHA and Freddie Mac, one of the 3 big buyers of loans in the mortgage  market) is about to roll out the newest version of their Automatic Underwriting System (AUS), DU 8.0. Most loans are now approved through an AUS which is a type of artificial intelligence program. The systems grade each loan for risk and produce a decision which says whether the loan meets their standards, or not. Getting an AUS approval is just the first step. We still have to make sure that all the information entered into the system is correct (garbage in – garbage out) and even if the loan meets Fannie Mae’s guidelines, we need to make sure it fits the extra lender requirements and do all the other things needed to approve a loan. But the odds of getting a conventional loan closed without an AUS approval are beyond slim. It’s not going to happen. So when a new AUS system comes out, this is a big deal. Home buyers who are qualified to buy under the present guidelines, may not be able to qualify under the new rules. And with the release of DU 8.0, a lot of buyers are going to be outside looking in.

A lot of the changes will be tweaking the formula, and some of the changes are taking away programs which all the lenders stopped doing ages ago. The new release does away with expanded approval loans (those with riskier profiles) and raises the minimum credit score from 580to 620. But in the real world, lenders haven’t accepted expanded approval loans in the last 2 years, and with all the price hits included, anyone with a score below 680 is likely to get better pricing with an FHA loan. There are other changes, like a reduction in mortgage insurance requirements, which will lower the cost of financing for some home owners.

The biggest change in the new release is a maximum debt ratio of 45% – or possibly 50% with strong compensating factors. The debt ratio is the total of the new mortgage payment and all your other debt payments divided by your income. The idea behind the debt ratio is to make sure you are able to afford the mortgage and not taking on too much debt. A borrower with a lot of money in the bank and high credit scores is a much safer risk than someone with lower scores and no reserves, so they should be allowed to manage a higher debt load. Back in the old days when I first started doing mortgages (and dinosaurs roamed the earth) the back end ratio was set at 36% for conventional loan, so the 45% (or 50%) isn’t awful. When they adopted the AUS system, much higher ratios were allowed because they were looking at the entire risk profile, not just one number. With strong borrowers it wasn’t unusual to get approvals when the total debt was well over 55% of the income we were showing (many borrowers have income coming in which we can’t use to qualify).  This change will  mean that a lot of well qualified buyers who are able to make their payments, won’t qualify for a Fannie Mae loan. Freddie Mac hasn’t announced that they are following through with similar changes, yet, so for now there are still conventional alternatives for borrowers affected by these changes.

With these changes, FHA is likely to increase their market share, again. FHA is in the same boat as its cousins Fannie and Freddie in that they are under pressure to increase their loan quality and up their reserves. FHA has already announced that they will be tightening their guidelines too, but because FHA financing was just a sliver of the market when the housing bubble was expanding, it doesn’t have the same level of problems that its conventional cousins do. Also, FHA is set up as a way to make financing affordable for more home buyers, so even as they tighten, they will still offer more opportunities to qualify. FHA has a stated back end ratio of 43%, but when run through the AUS much higher ratios are common. You are only hurting yourself if you buy more than you can afford, but there are so many situations where a one size fits all approach doesn’t apply. It’s good that is still an option. At least for now.

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