Mortgage Risk on the Rise

A key measure of lending behaviors shows the number of risky mortgages rose in September as housing agencies fail to compensate for high debt-to-income (DTI) ratios.

The American Enterprise Institute's (AEI) National Mortgage Risk Index, released Monday by the group's International Center on Housing Risk, rose to 11.43 percent in September, little changed from the revised average of the previous three months and nearly 1 percentage point higher than a year ago.

The risk index measures stressed default rates on home purchase loans, including mortgages purchased by Fannie Mae and Freddie Mac and those insured by the Federal Housing Administration (FHA) and the Department of Veterans Affairs (VA). Including an additional 232,000 loans added in September, the index covers approximately four and a half million mortgages.

In keeping with recent trends, the index measuring risk for FHA loans was the highest, sitting at 23.99 percent—nearly quadruple the 6 percent threshold AEI considers to be stable. Over the last year, that index has climbed 2.1 percentage points.

Meanwhile, the newly added VA index had a risk rating of 11.24 percent, slightly below the composite index. Based on key risk factors, including credit scores, total DTI, and loan-to-value ratio, AEI says VA loan characteristics make those mortgages about 20 percent less risky than FHA loans. Controlling for borrower and loan characteristics, the VA's default rate on 2007 loans averaged only about 60 percent of the FHA rate.

"If the FHA were to emulate the VA's risk management practices, the composite would drop to about 9 percent," the group said.

The stressed default rate for loans purchased by Fannie and Freddie remained just on the stable side at 6 percent.

Out of the number of risk factors at play in September's index, AEI says the standout continues to be the high volume of loans with excessive DTI ratios. Over the past three months, the association estimates 22.3 percent of loans had DTI ratios above 43 percent, the cutoff established under the Consumer Financial Protection Bureau's qualified mortgage (QM) definition. Mortgages qualified for purchase by the GSEs or for insurance by FHA are temporarily exempt from that provision.

"FHA is not compensating for riskiness of high DTI loans; Fannie and Freddie are compensating only to a limited extent," AEI said.