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Mortgage Risk Index Declines Slightly

The American Enterprise Institute (AEI) reported a very slight retreat in mortgage loan risk in May, though risk levels remain at nearly double the maximum safe level.

AEI's National Mortgage Risk Index [1] (NMRI), released monthly through the institute's International Center on Housing Risk [2], registered 11.87 percent for May, down from April's revised reading. The institute considers any index value below 6 percent as "indicative of conditions conducive to a stable market."

The index acts as a stress test, measuring the percentage of loans at risk of default in the event of another economic crisis. With the addition of 181,000 in May, the NMRI now tracks a total of 3.54 million loans.

The stressed default rate among GSE loans came in at 5.9 percent, just below the 6.0 percent threshold. However, the component index measuring risk among loans insured by the Federal Housing Administration (FHA) was up to 24.2 percent.

According to analysts for AEI, the biggest factor behind today's elevated risk environment is the number of loans with high debt-to-income (DTI) ratios. Though guidelines implemented earlier this year stipulate that a loan cannot exceed a DTI ratio of 43 percent to fit under the qualified mortgage (QM) definition, the rule carves out a temporary exemption for eligible GSE and FHA loans.

Because of this exemption, AEI says there's been "little discernible impact" from QM, as nearly a quarter of loans measured for the index still have total DTI ratios greater than 43 percent. What's more, analysts say FHA is not compensating for the elevated risk, while Fannie Mae and Freddie Mac are "compensating only to a limited extent."

AEI also dismisses the idea that the credit box needs to be opened up more to revive the flagging recovery, asserting that "recent softness in mortgage lending [is] not due to tight standards but to somewhat higher interest rates, higher home prices, [the] lingering impact of the financial crisis, and [the] sluggish economic recovery."

At the state level, risk percentages ranged from just above 7 percent in Hawaii to higher than 16 percent in Mississippi, with more states falling in the 10–14 percent range.

"Those at the extremes tend to have high or low concentrations of FHA/RHS [Rural Housing Services] loans," AEI said in its report.