Hidden Liabilities: BNPL Debt, Crypto Reserves Threaten Mortgage Stability

Two fast-moving trends — Buy Now, Pay Later (BNPL) loans and cryptocurrency holdings — are blurring the lines by hiding risk and overstating borrower strength which could destabilize lending.

America’s Credit Unions is asking the U.S. Department of Housing and Urban Development (HUD) to factor in BNPL into Federal Housing Administration (FHA) underwriting standards.

“Phantom debt” related to BNPL poses risks to borrowers and housing market stability, according to America’s Credit Unions’ response to a request for information from HUD on the issue.

FHA guidelines exclude short-term debts — loans repaid within 10 months or under 5% of income — meaning many BNPL loans slip by unnoticed. That gap can make borrowers’ debt-to-income (DTI) ratios look stronger than they are, heightening approval risks.

Meanwhile, the Federal Housing Finance Agency Director William Pulte authorized a directive to Freddie Mac and Fannie Mae in June to draft proposals to allow consideration of holdings of cryptocurrency as mortgage reserves.

It could allow borrowers to broaden financial profiles without converting crypto holdings into U.S. dollars.

The directive also requires risk mitigations like volatility adjustments, designed to contain exposure in the event market swings erode the values of assets. Consumer advocates are dubious, however, since crypto’s volatility makes it an unsound buffer.

When valuations fall precipitously, borrowers relying on digital holdings may suddenly appear less secure, make lenders question reserve adequacy, and mandate adjustments to risk models.

The risk of exposure is substantial. Over 60% of BNPL customers had multiple active debts in 2022, layering debt obligations that exacerbate payback stress. Meanwhile, crypto assets swing wildly over periods of days, putting strains on underwriting models developed to operate in more stable landscapes.

HUD’s request for information foreshadows upcoming changes, including potential mandates to disclose BNPL obligations, include obligations in debt-to-income formulas, or increase information exchange with credit bureaus.

For the Federal Housing Finance Agency (FHFA), the crypto reserve discussion may establish precedent on whether regulators welcome alternative assets or remain prudent.

These aren’t insignificant changes for lenders and underwriters — they’re redefining risk assessment. Omitting information on BNPL debt could underestimate the likelihood of default, and overstating crypto reserves could erode faith in government-sponsored enterprise (GSE) securities.

Each of these changes casts a particularly large shadow for subprime-specialized lenders. BNPL products are hugely popular for borrowers with thin files or low scores, causing invisible exposure when such debts stay off the books.

If FHFA is to account for volatile crypto assets in its reserve measure, it may assume subprime applicants to have better liquidity than they do in fact.

Both of these work to bind underwriters in a quandary of separating perceived capacity from actual financial soundness, raising the risk of mispriced loans and delinquency potential in vulnerable borrower groups.

Regulators are now caught between pressures from lawmakers, consumer watchdogs, and financial markets. HUD’s examination of BNPL disclosure and FHFA’s crypto reserve discussion reflect how underwriting models are having trouble evolving to shifting borrower needs, rising BNPL use, and volatile crypto holdings.

Creditors are stuck weighing innovation against resilience. BNPL’s invisibility threatens mispriced loans, and crypto’s volatility makes reserve estimation harder. Borrowers may in turn face fluctuating qualification levels as regulators refine definitions of acceptable risk.

Until HUD and FHFA make a decision, underwriters can anticipate possible changes to FHA guidelines, treatment of reserves, and DTIs. Companies that adjust early — by incorporating BNPL data, adjusting crypto valuations, and strengthening reporting structures — will better withstand a dynamic environment.

The mortgage markets are at a junction. To ignore these products is to destabilize one’s book, and to overcompensate is to restrict access to credit.

Against pressures from HUD and FHFA, underwriting guidelines that had seemed carved in stone are being rewritten by the emergence of BNPL and crypto assets. As financial products evolve, so too must the instruments and models crafted to contend with them.