Serving Today's Mortgage Market: Adding Flexibility without Adding Incremental Risk

Jonathan Lawless
Vice President
Underwriting, Pricing,
and Capital Markets

Fannie Mae is focused on working with our lenders to help them grow their businesses and reach new markets without adding incremental risks or costs to the industry.

Fannie Mae’s HomeReady mortgage product helps lenders reach creditworthy low- to moderate-income borrowers through innovative product flexibilities designed to address the needs of today’s borrowers.

Flexibility for Shared Households
For a variety of reasons, many homeowners share their house with relatives or friends. When I was growing up, my parents made the decision to live with my grandparents to allow my family to live in the community and house we wanted. This multigenerational living arrangement is a common form of a shared household, but other arrangements exist as well, such as families of the same generation living in the same home.

Shared households are more common among underserved populations, including low- to moderate-income, minority, and immigrant populations, than among other households. The motives may be cultural or economic, and in many cases these households are “extended-income households,” or EIHs1, meaning there is additional, significant income being earned by the co-resident. We define income as being significant if the co-resident earns 30 percent or more of the amount that the mortgagees earn.

Percentage of EIHs by Race/EthnicityThe population of EIHs is significant: Among all households with a mortgage (based on 2013 data – the most recent available), 14 percent are EIHs. This share is 25 percent of Hispanic, 20 percent of African-American, and 17 percent of Asian households with a mortgage. The National Association of Realtors reports that 13 percent of home purchases in 2014 were by a multigenerational household (National Association of Realtors 2015 Home Buyer and Seller Generational Trends Report).

In some households, a resident may pay a set amount of “rent” for sharing the living quarters, and Fannie Mae continues to allow such boarder income to be counted explicitly as part of the borrower’s income for HomeReady, lowering their debt-to-income ratio. But in many cases, relatives or friends sharing a home may pay for groceries or other expenses (like my parents did) rather than making a formal rent payment, so their financial contributions are not recognized in a traditional underwriting process.

HomeReady challenges tradition by offering an innovative new feature that supports extended households. This flexibility allows consideration of income from non-borrower household members (relatives or non-relatives) as a compensating factor in Desktop Underwriter® (DU®) to allow for a debt-to-income (DTI) ratio above 45 percent and up to 50 percent. We know from our research that not only are these household arrangements common, but the borrowers are more likely to find income a constraint to accessing credit.

But Is It Risky?
Since we announced HomeReady in August, Fannie Mae has heard this question from our lenders and others: “Doesn’t the non-borrower household income flexibility add risk?”

Our decision to offer this flexibility is based on two key factors.

First, the extended-household income is used only to allow the borrower to have a higher DTI ratio (maximum 50 instead of 45), but not considered in DU’s credit risk assessment. When a loan casefile is underwritten through DU, the system evaluates mortgage delinquency risk to determine if the loan satisfies Fannie Mae’s credit risk standards, and then determines if it meets our mortgage loan eligibility criteria. The EIH flexibility is used in just one of the eligibility rules – the DTI cap – and does not impact the credit risk assessment. This means that loan casefiles for borrower(s) using EIH must still meet our credit risk standards (receive an Approve recommendation) using only their qualifying income. If we included the additional household income as qualifying borrower income instead of simply counting it as a compensating factor, the DTIs for these loans would be below 40 percent.

Second, our research using publicly available data2 has shown that the additional household income can be a risk offset:

  • Loan Performance – Borrowers Stay in Home and Pay: During the research period studied, borrowers in EIHs were less likely to move out after being underwater than those in non-EIHs. The data suggest that borrowers in EIH households were more willing to continue making mortgage payments when underwater, perhaps due to attachment to the home and the economic benefit or hedging effect of the additional household income.3
  • Income Stability – No Less Stable than Other Households4: We also examined the stability of income for EIHs compared with standard households and found that, for the research period examined, EIH households were similar in terms of overall variability. Our research also noted that EIHs over this period had a slightly higher chance of small negative income shocks, but they were less likely to have very large income drops.

Adding Flexibility without Adding Incremental Risk
Based on our research, Fannie Mae believes that allowing the existence of non-borrower income to be considered when qualifying the borrower for a HomeReady mortgage helps to expand access to mortgage credit for creditworthy borrowers without adding incremental risk.

From an overall risk perspective, we believe that the presence of additional household income will reduce credit risk, although we will continue to take a conservative stance and continue to assess the credit risk of these loans excluding the additional income. We believe that having diversified income sources is a good way to prevent large shocks to an overall household’s income. That’s why we currently anticipate that loans where the borrower(s)’ DTI is up to 50 percent with extended-household income will perform better over time than loans for borrower(s)’ with a 45 percent DTI without it. This is a flexibility that will help our lenders serve today’s market.

Lenders can underwrite HomeReady loans with confidence using DU’s comprehensive credit risk assessment and eligibility determination, and get the certainty provided by DU’s limited waiver of representations and warranties. As an added risk mitigant for the EIH flexibility with HomeReady, the non-borrower must 1) document his or her income, and 2) sign a statement of intent to reside with the borrower(s) for a minimum of 12 months. And as mentioned above, the non-borrower’s income is considered by DU only as a compensating factor allowing a higher-than-standard DTI ratio, and is not considered part of qualifying income.

We continue to work every day to support sustainable homeownership for creditworthy borrowers and to be America’s most valued housing partner.

For more information, visit the HomeReady web page.

Research conducted by Walter Scott, Fannie Mae senior economist.

Jonathan Lawless
Vice President, Underwriting & Pricing Analytics
Underwriting, Pricing and Capital Markets

February 2, 2016

1 For our purposes, we define an EIH as a household with a mortgage and people living in the home who are not borrowers on the mortgage but have income equal to at least 30% of the mortgage borrowers’ income

2 Data sources: American Housing Survey (panel of 50,000 households surveyed every two years) and American Community Survey.

3 Note: No direct performance data is available on EIH mortgages; we created an indirect measure of loan performance using AHS data.

4 Income stability was tested by comparing the risk of borrower income falling by 10–50 percent over two years. For EIHs, potential support equal to 30 percent of non-borrower income was added to borrower income.