Monday, April 25, 2011

The Federal Reserve's Newest Proposed Rule--Underwriting Guidelines

On April 19, 2011, the Federal Reserve published a proposed rule to establish minimum underwriting guidelines for mortgages, as required by the Dodd Frank bill.
Last week I wrote about the Qualified Residential Mortgage proposal introduced by the FDIC.  The Federal Reserve's proposed rule is not nearly as detailed as the FDIC QRMs, but the underlying philosophy is pretty similar:
The Federal Reserve's proposal will apply "the ability to repay requirement to all consumer purpose mortgages, (except home equity lines of credit, timeshare plans, reverse mortgages or temporary loans)." To achieve this, the Federal Reserve proposes 4 compliance options 1. General Ability to Repay Standard, 2. Qualified Mortgages,  3. Balloon Payment Qualified Mortgages, 4. Refinancing of a Non Standard Mortgage.   Within each of these 4 compliance option categories are various sublevels of compliance.
For example, to meet the general ability to repay standard, an underwriter needs to consider the following 8 underwriting categories:
  1. Income or assets of the borrower
  2. Current employment status
  3. The monthly payment on the mortgage
  4. The monthly payment on any simultaneous mortgage
  5. The monthly payment for mortgage related obligations
  6. Current debt obligations
  7. The monthly debt-to-income ratio or residual income
  8. Credit history.
The creditor must also make sure that when he is underwriting an adjustable rate product, he is qualifying the borrower on the fully indexed rate.
The Federal Reserve is also trying to solidify their own definition of a "qualified mortgage" which is interesting since the FDIC is currently seeking comments on its own, massive qualified residential mortgage proposal.  The Federal Reserve's proposal to satisfy this requirement is actually more reasonable than the FDIC's.  The Fed Rule proposal merely says that the QRM should not contain negative amortization, interest-only payments or a balloon payment or exceed 30 years in term.  A QRM also would not have points and fees exceeding 3% of the total loan amount.  Income and assets must be verified to determine ability to repay and the loan must be underwritten using a fully amortized payment schedule over the loan term.

The 3% cap on points and fees is part of the Dodd Frank bill, but it will be interesting to see how that aligns with recently adopted industry practices as part of the loan originator compensation rule.  For instance, under the new rule, originators have a ceiling and a floor for loan origination fees.  If we are originating a loan of $60,000.00 we can set a floor at $1000.00.  However, with lender fees consistently rising (some wholesale lenders are now charging about $800.00 for their administration fees), and with states such as Texas requiring attorney fees as part of the origination fees, that is going to leave very little money for the originator.  If I have to pay the lender $800 and the law firm that prepares the documents an additional $300.00., on a $60,000 loan I am left with only making $700.00.  These fee caps are going to keep a lot of the smaller loans from getting done at all in a situation where the loan originator is commissioned.

Additionally, the Federal Reserve is proposing that the QRMs meet the following additional underwriting standards in which the underwriter considers:

  • The consumer's employment status
  • The monthly payment for any simultaneous mortgage
  • The consumer's current debt obligations
  • The monthly debt to income ratio or residual income and
  • The consumer's credit history.
Recognizing that rural properties create special challenges for the lending community, the Fed's Rule allows for balloon payment qualified mortgages. "This option is meant to preserve access to credit for consumers located in rural or underserved areas where creditors may originate balloon loans to hedge against interest rate risk for loans held in portfolio."  Under the proposal, balloon payment mortgages with a term of five years or more qualify as long as the loan complies with the other requirements for a qualified mortgage.

Finally, the Federal Reserve's proposal allows a creditor to refinance a non-standard mortgage into a "standard mortgage" using streamline mortgages.  Under this part of the proposal, a creditor would be able to refinance a consumer into a mortgage with caps on points and fees without verifying the consumer's income or assets as long as the other requirements of the ability to repay section have been met.

The Federal Reserve's proposal with lengthen the amount of time that creditor are required to keep files and will prohibit structuring an closed end line of credit as an open ended line to evade the statutes.

While the individual points of this proposal are not bad, I do have a huge issue with codifying underwriting guidelines into federal law.  By setting up federal underwriting guidelines for mortgage lending, the government does not leave any room for the creation of new products or for individual analysis of the borrower's situation.  We see that in a major way with the FDIC's Qualified Residential Mortgages and on a much smaller scale with the Federal Reserve's proposed rule but the basic problem is the same.  The federal government should not be in the business of establishing lending criteria.

Comments are open until July 22, 2011. However, since the Consumer Financial Protection Bureau is scheduled to take over TILA rulemaking on July 21, 2011, the Federal Reserve will not be issuing a final rule. 

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