Can anyone direct me to a source that describes how/when/why 40% is used as the "standard" for D/I ratios? I assume somewhere along the way there was some study or statistical analysis that determined that X% of borrowers over this ratio had late payments or defaults. But, where did this information come from and/or who came up with it?

I'm in the position of having to explain/prove the importance and value of the D/I ratio and that is hard to do unless I can say where or how it originated.

Thanks!

Used to be 36% then 38% and now 40% some even 45%. Many home equity lenders are now using 50% as their threshold!

For residential mortgage lenders, industry standards, secondary market standards, risk tolerances all play into the determination. For consumer lenders, with less of a secondary market presence, the individual risk tolerance of the lender is important.

Think about it in reverse though to understand where income can be allocated. Starting with a pool of 100% of your income: 15-20% can be allocated to federal income tax; 3-5% to state income tax; then other living expenses such as: insurance (auto, health, life, ex housing)can easily eat up 10% of gross income; food; utilities (elec, water, natural gas, cable phone, cell phone, internet); GAS!; medical copays; clothing; etc etc etc can easily all add up to 50% of income or greater, depending on the number of members in a household and their lifecycle.

Thanks for the information. But, what I'm looking for is information to support the percentage. Why 40% and not 50%? Are there statistics that support that after 40% there are more delinquencies or defaults? Or was it just a standard that someone said is "acceptable"?

What I'm trying to do is justify the fact that you MUST have something in place for D/I and that it needs to be within certain industry standrads. But I need some documentation to support why and how it came to be.

Maybe it's just one of those "It's always been this way" kind of things.

Rubaiyat, anon made a good point that people need some money at the end of the month to exist on. Many lenders for RE loans follow the FannieMae/FreddieMac guidelines.

The DI ratios Fannie/Freddy use have become pretty close to industry standard and they continuously monitor the root causes for delinquency. If they determine that a 42% DTI potentially causes delinquency, they will lower it. Conversely, if they determine that a 42% DTI has no bearing on delinquency, they will raise it so they can make more loans.

Not many banks have the statistical tools and historical loan/default volume to determine optimal DTI ratios, but rely on the GSE's and other large lenders (Countrywide, Wells, WAMU, Citi, etc.) for guidance. All are fairly consistant so one does not have a significant advantage over the other. The GSE's underwriting guidelines are available on AllRegs.

As far as the "must" have something in place, IMHO you definitely should. It is the only guideline you have to support income consistancy in underwriting, and one of the first things that examiners look for in evaluating your portfolio for prohibited lending biases. (They would get the policies and review your files to see how the policies are adhered to.) Without policies, generally experienced underwriters have and take more liberties than a new one. This makes underwriters document why they did not adhere to policy.

Hope this helps a bit.

You need to look at predatory lending laws only. If you make a person a $100,000 loan on their home with a 60% DtoI, are you lending on their ability to repay or the equity in the home. Equity base lending is no longer an acceptable lending basis. If you don't have a sound lending policy in place, which addresses the ability to pay, you are looking for trouble both fro a predatory lending perspective and a safety and soundness perspective.

I meant to say predatory lend laws also, not only.