Home builders are accustomed to taking risks. They buy land assuming the economy won’t crash, interest rates won’t skyrocket, and many other unknowns. As if home building wasn’t hard enough already, there’s a new risk: the QM (qualified mortgage) patch.
The QM patch exempts Fannie Mae and Freddie Mac from Dodd-Frank’s 43% DTI (debt-to-income) ratio cap. This expires January 2021, potentially jeopardizing up to 14% of the mortgage market.¹ While a portion of this 14% will likely shift to the looser underwriting / more expensive FHA option, some buyers could be removed from the market altogether.² Why? In many housing markets FHA loan limits are 50%+ lower than Fannie/Freddie loan limits.³
In the table below, we highlight loan limit gaps across a dozen major housing markets (~10,000+ single-family permits in 2018).
Hover over the dots and click on the different housing markets in the map below to view additional data and filter the map along with the line chart showing historical loan limits.
Our suggestion for home builders: Pivot away from homes priced between the FHA and Fannie/Freddie loan limits, especially if those buyers have 43%+ DTI ratios or very low down payments.
- Analyze risk exposure. Identify communities at risk where the mortgages required exceed FHA loan limits and fall below Fannie/Freddie limits. To help, you can use our interactive loan limit map above.
- Strategically sell through. Sell out of those impacted communities before January 2021, especially if you have many buyers with high DTI ratios.
- Avoid certain land buys. Avoid buying land today where homes will fall in this loan limit price gap range, or at least consider the additional risk before purchasing the land.
- Add more mortgage providers. Broaden your range of mortgage providers to include non-QM lenders who can replace those who underwrite for Fannie and Freddie.
Builders are making big investments today, unsure if policy shifts 16 months out will derail a decent portion of their buyers. The QM patch could possibly be extended, but that is a risk builders should at least be considering in their strategies now. To be clear, we’re not trying to argue for a continuation of the QM patch. However, we, as well as our clients, would like as much visibility now from policy makers given the multiyear investment time line associated with home building.
1Fannie- and Freddie-backed mortgages accounted for 46% of the market in 2018, of which roughly 30% went to buyers with 43%+ DTI ratios. Thus, roughly 14% of 2018 mortgages fell under the QM patch (30% of 46% = 14%).
2FHA-insured mortgages are not affected by the QM patch and allow for lower credit score and down payment requirements than Fannie/Freddie, with DTIs as high as 57%.
3The difference in loan limits is by design, as the FHA loan program was created to support low- and moderate-income home buyers (hence, lower price points). Congress and HUD set FHA loan limits annually, whereas the FHFA sets Fannie/Freddie loan limits.
If you have any questions, please contact Rick Palacios Jr., Principal and Director of Research at (949) 870-1244 or by email.
Follow Rick on Twitter: @RickPalaciosJr