Thursday, January 27, 2011
Making the World a Safer Place for Mortgages
Appearing on the Fox Business Channel January 19, 2011, the FDIC chairwoman Sheila Bair, was asked about the new class of residential mortgages, "qualified residential mortgages". Qualified residential mortgages are a class of mortgages created under the Dodd Frank rule which exempts certain types of mortgages from the law's 5% risk retention rule. QRM's may be sold without the lender having to retain any part of the loan in their portfolio, but they must conform to strict new guidelines.
How strict? When asked this question on FBC, Bair responded that qualified residential mortgages which can be sold on the secondary market will have "more pristine standards" and "additional requirements to qualify."
Since the standards are actually being written right now by federal regulators, it is too early to know yet exactly what will be included in the final definition of a qualified residential mortgage. One fact that does appear to be emerging pretty clearly is that these mortgages will require no less than 20% down payment. Wells Fargo had issued a proposal for 30% down, but Bair rejects that as excessive, saying that the 20% downpayment worked well for many years to create safe and secure residential mortgages.
In a lending environment as tough as this one, it is hard to imagine underwriting standards becoming even more strict than they are now. But that is exactly what is about to happen. Freddie Mac issued a statement late last year that their average credit score for a mortgage loan is over 750. Debt ratios cannot exceed 50% except on special refinance transactions for loans that Fannie Mae and Freddie Mac already own. All documentation in the file is checked and rechecked.
So how could underwriting standards become more pristine? Actually, they could tighten in several ways. Some regulators have been calling for appraisal reviews for files being sold on the secondary market. We might see QRMs require a mandatory full appraisal and an appraisal review for each loan. That would raise borrower costs substantially, but it would give the lender and the servicer an added layer of protection. And we probably can expect to see debt ratio guidelines tighten--perhaps to 40% total debt to income or perhaps even lower--to the old ratio cap of 33%. That would mean that the total borrower monthly debt including the housing payment, could not exceed 33% of the gross monthly income.
This will certainly make mortgages safer. Unfortunately, it will also make them much less available, and it will make homeownership more expensive and less attainable. Consider Ms. Bair's statement that the 20% downpayment served us well for many years. The 20% standard was developed at a time when housing prices were much lower than they are today. My parents bought their first home in 1967 for $16,000. At 1650 square feet, the home was purchased brand new from the builder at less than $10.00 per square foot! I have since seen the home; it was a well designed, well-built three bedroom home with a master suite and built-in kitchen appliances, sitting on a large lot in a new subdivision. (Incidentally, my parents used my father's VA to purchase the home so they did not make a 20% downpayment even then. It cost my parents $100.00 to close on their first home, and they had an escrowed monthly payment of $102.00.) Today, that same home is on the city tax rolls for $110,000.00
In an era where credit cards were basically non existent, and home prices were low, young couples could save their money and make a down payment on a home. How times have changed. Most cars today cost more than my parents' first home The average price of a home nationwide is more than $170,000. With credit cards and car payments, child support payments, etc. most potential borrowers cannot meet the tough new standards for underwriting under qualified residential mortgages.
And this is the conclusion of Washington D.C. policy think tank MF Global, which was quoted in Housing Wire on January 24, 2011, saying that we are creating a situation "where less-than-perfect-borrowers have no ability to get mortgages, which could make an already tight mortgage market even tighter." Most industry experts believe that banks will come up with a set of portfolioed mortgages which allow less than 20% down payments and have less stringent underwriting standards. However, in practice, how many lenders are going to want to relax standards on mortgages in which they must retain at least 5% ownership?
All of this equals a tighter housing market in 2011. As the pool of qualified homeowners gets increasingly smaller, and mortgage loans become increasingly difficult and expensive to obtain, more and more Americans are going to find that the American Dream of homeownership is just too far out of reach.
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