DTI’s Ties to Mortgage Default Rates

In an effort to reduce future defaults on FHA-insured mortgages, the Federal Housing Administration (FHA) has signaled that it may tighten credit, noting that the debt-to-income (DTI) ratio for FHA-insured loans has been consistently increasing for six years. In a new report, Urban Institute examined  how important DTI ratios in predicting a borrower’s ability to make on-time mortgage payments, and how debt burden impacts ability to repay FHA mortgages.

According to Urban, DTI ratios are much less significant predictors of loan performance than FICO scores and that many high-DTI loans have strong FICO scores. Additionally, Urban’s analysis found that higher-DTI loans do not always have higher serious delinquency rates, and 5.6% of loans with DTI ratios ranging from 0 to 35% have been seriously delinquent at 60 months of age, compared with 7.6% of loans with DTI ratios of 35–45. But for loans with DTI ratios greater than 50, the D90+ rate at 60 months is 6.9%, lower than those with DTI ratios of 35–45.

On the other hand, loans with lower FICO scores—and loans with higher loan-to-value (LTV) ratios, for that matter—always have higher serious delinquency rates. The magnitude of impact on delinquency rates is much larger than on DTI ratios, ranging from 3.3 to 12%. For FICO scores, the proportion of loans that was ever D90+ delinquent at 60 months ranged from 3.3% for loans with FICO scores greater than 780 to 12% for loans with FICO scores less than 620, or a factor of 3.5.

Urban concludes that there is no question that higher-DTI loans default at higher rates than low-DTI loans, but even in the FHA market, the relationship is weak. FICO scores are much stronger predictors of default than DTI ratios.

“Also, it appears that the current FHA scorecard adequately captures DTI ratios, requiring compensating factors for high-DTI ratios,” said Urban. “If the FHA were to place further restrictions on DTI ratios, it would not benefit the FHA and would make obtaining mortgage credit more difficult for two important groups: millennials with student loan debt and communities of color, who generally have lower incomes.”