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The Mortgage Patch and Default Risk

The American Enterprise Institute’s (AEI) latest Housing Market Indicators identified tightening credit. The Composite NMRI for purchase loans declined 0.4 percentage points year-over-year, the fifth month for this trend.

The First-time Buyer (FTB) MRI continued to decrease led by Fannie Mae, which has been tightening since March 2019. FHA’s First-time Buyer MRI stood at 27.8% in October, down 0.7 percentage points from a year earlier.

“While this change is encouraging, the decrease is coming off of very high risk levels and more needs to be done,” AEI said.

AEI also analyzed housing finance reform and the patch: AEI's report covered the impact adopting an average prime offer rate (APOR) spread rule would have compared to the Patch.

According to First American, “adopting an APOR rate spread rule is worse than the Patch and would be dangerous.”

“Replacing the Patch with the APOR would not provide friction to the unsustainable home price boom, particularly for entry-level buyers,” the report states.

AEI also states that a safer solution than APOR would be to eliminate the 43% DTI limit applicable to QM loans and substitute a stressed Mortgage Default Rate (MDR) limit, “which actually captures risk holistically, while ensuring responsible, affordable mortgage credit availability.”

As AEI says, there is a wide variation in the Mortgage Default Rate as APOR only captures risk accurately on average. According to the proposal, eliminating the 43% DTI limit applicable to QM loans and substitute a stressed Mortgage Default Rate (MDR) limit, the change would address concerns that several institutions have expressed in comment letters.

For example, the Housing Policy Council recommends elimination of DTI requirement and use of rate spread as a more “holistic approach.” Urban Institute has als stated that “DTI ratio by itself does not capture credit risk comprehensively.”

About Author: Seth Welborn

Seth Welborn is a Reporter for DS News and MReport. A graduate of Harding University, he has covered numerous topics across the real estate and default servicing industries. Additionally, he has written B2B marketing copy for Dallas-based companies such as AT&T. An East Texas Native, he also works part-time as a photographer.
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