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Defining 'Affordable' Loans: There's No Easy Answer
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In principle, government could close this escape valve by freezing the qualification ratio. Twenty-five years ago, this might have been possible. Ratios of 36 percent and 28 percent, measured with and without non-mortgage debt service, were then more or less the norm. As underwriting systems have evolved, however, maximum ratios have changed. They now vary from one loan program to another and with other factors that affect risk, such as credit score, down payment, type of property and loan purpose.
Government intrusion into this complex process to make the fully indexed rate rule effective would be a disaster, and nobody has suggested it.
Proponents of the fully indexed rate rule either don't realize how easily the rule can be evaded, or are satisfied just to go through the motions. If the rule were effective, they might be forced to confront a really thorny issue.
Any government underwriting rule that is more restrictive than those selected by lenders, and which cannot be evaded, will reduce the number of households that qualify for loans. Of the group that is cut from the market, some would have lost their homes through default and foreclosure had they received loans. This is the intended benefit of the more restrictive rule.
A larger number, however, would have become successful homeowners under the previous rules and are now denied this opportunity. This is the unintended but inescapable cost of the restrictive rule.
To prevent one foreclosure by tightening standards, we prevent a larger number of successful loans. I don't know what that number is, or what society should view as an acceptable number. These questions have been studiously avoided.
Next Saturday: Unaffordable loans that are in the public interest.
Jack Guttentag is professor of finance emeritus at the Wharton School of the University of Pennsylvania. He can be contacted through his Web site, http:/
Copyright 2007, Jack Guttentag
Distributed by Inman News Features
