Wednesday, April 20, 2011
Qualified Residential Mortgages--The Worst Idea Yet
Last week, the House Financial Services Committee held a hearing on the new proposed qualified residential mortgages. Henry V. Cunningham testified on behalf of the Mortgage Bankers' Association about the impact of the new proposed requirements for consumers. The Mortgage Banker's Association is one of a number of groups to include the National Association of Realtors, and several consumer advocacy groups to oppose this new proposed rule. And as we read the rule, we can see why. Of all of the proposals that I have seen over the past three years, the Qualified Residential Mortgage reigns supreme as the worst, and I am including the Federal Reserve's loan originator compensation rule which was just implemented on April 6 in that statement.
Why? The other proposals and rules primarily hurt and discriminated against small business people. But the QRMs are aimed squarely at the consumer. The Qualified Residential Mortgages declare open war on the American dream of homeownership and put that dream out of the reach of most Americans. Qualified Residential Mortgages make downpayment and qualification requirements so strict that even financially strong, creditworthy borrowers cannot qualify for a residential mortgage.
The new proposed guidelines require a 20% down payment for a purchase, 25% equity for a refinance and 30% equity for a cash-out refinance. The borrower's debt to income ratio cannot exceed 28% for his housing ratio to his income and 36% for his total debts to his gross income. As Cunningham points out in his testimony, these ratios do not have compensating factors--allowing, for example, high cash reserves to be used to offset a higher ratio. As an additional blow, any borrower with a 60 day delinquency on his credit report will not qualify for a QRM.
Using these guidelines, only 20% of the loans sold to Fannie and Freddie over the last 10 years would have met the criteria of a QRM. The Federal Housing Finance Authority found that less than one-third of loans sold to Fannie and Freddie in 2009 would have met the QRM guidelines, and 2009 was one of the strictest underwriting years on record.
To put this in perspective, I went through the files that I have done this year for my borrowers. I have an upper middle-class customer base of professionals who have used me almost exclusively for their financing over the years that we have worked together, so I thought it would be interesting to see how their credit profiles would align with the QRM guidelines.
Borrower # 1 owns a catering company here in the area. She does catering for government functions, and she also sells speciality items to restaurants. In February, she wanted a rate and term refinance for her primary residence. She has excellent credit and is filing a low six figure income on her tax returns, but she and her husband are getting older. She had previously refinanced her home on a 15 year loan in 2008 and she wanted to take advantage of the lower rates and drop from a 5.875% to a 4.5% rate on her home. Her credit scores are low 700s. Borrower # 1 would not qualify for a mortgage refinance under the QRM proposal because her debt to income ratio is 49% and her loan to value is 79%, so she would not be able to take advantage of the lower rates which shaved 1.375% off her interest rate and $450.00 a month off of her payment.
Borrower # 2 is a physician who works for a hospital. He is single and he owns a primary residence, a second home in another city in Texas, and he is also making payments on view lots that he purchased a couple of years ago for nearly $500,000 on which he plans to someday build his dream home. Borrower #2 is making over $500,000 a year and has no dependents, but part of his income is bonused at the end of the year, so the underwriter does not consider it in the income calculations. His 797 mid credit score and many years of credit history combined with his retirement accounts containing several hundred thousand dollars make him a good credit risk. Borrower #2 recently decided to refinance both his home and his second home to take advantage of lower rates. Under the QRM proposal, Borrower #2 would not qualify, because the underwriter qualifies him only on a small portion of his income and with all of the mortgage payments he is making on his three properties, plus his two car payments, his debt ratio is 40%.
Borrower #3 is also a physician. Borrower #3 has a family, and they want to purchase a bigger home more suitable for their growing situation. Borrower #3 has an income of about $300,000, but he just received a bonus of $500,000 which he used to pay off his existing home since he has not been able to sell it. Borrower #3 married later in life and his final holdover from his bachelor days is an expensive collection of luxury vehicles, part of which he is still making payments on. He is financing only 80% of the sales price of his new home, but he still has to qualify against the property taxes on his existing home and the homeowners insurance on his existing home. Since Texas property taxes are very high, those payments are considerable. He also has a small collection item that he recently paid. Borrower #3 would not qualify under the QRM because even though his debt ratio is only 34%, he had an account that went into collections so he would violate the 60 day delinquency part of the rule.
Finally Borrower #4 is a financial planner who makes $300,000 a year. He recently married and he is selling his home. With his child support, his car payments, his wife's new car payment, and his credit card debt, he has a 40% debt to income ratio for the new house he is purchasing. In addition, Borrower #4 wants to put only 10% down on the purchase of his house so he is seeking a first and a second lien. Borrower #4 has a lot of money in investments and a 710 score, but his debts are too high and his down payment is too small to meet QRM guidelines.
All of these borrowers are considered strong and an excellent credit risk, but none of them would qualify for financing under the QRM proposal. In fact, Standard & Poors released their findings of the Qualified Residential Mortgage rules last week. According to their findings, the QRMs will produce higher quality originations, but they will constrict credit and cause housing prices to continue to plummet. I don't doubt that the QRMs will produce lower-risk mortgages; the lowest risk loan is the one that is not made at all. I am reminded of the Book of Proverbs, "An empty stable never needs cleaning, but there is no income from an empty stable."
We keep hearing from the FDIC that the QRMs are to be a "small slice of the market" and that the great majority of mortgage loans will require 5% risk retention by the originator. These loans will supposedly offer expanded lending guidelines. But a little industry experience teaches us that this is not true. Portfolio loans, while traditionally having somewhat more flexible guidelines, usually require a lot of down payment. For examples, look at the old World Savings portfolio loans. These were basically 20 to 30% down payment stated loans. The security that World Savings had was the down payment. As Cunningham points out in his testimony, most private portfolio loans today have to loan values near 60%. For example, residential mortgages originated through some major insurance and investment companies offer really low interest rate ARMs with down payments between 30 and 40%. The strong equity position of the lender protects them against default. So if the QRM guidelines become the standard for what a safe loan should be, we are very naive to think that large banking entities which are forced to retain 5% of the loan for the life of the loan are going to rush to create a lower down payment product. That's just not the way it works.
Where the risk retention products will step in, I believe, is in allowing higher debt to income ratios. Rather than requiring a 36% debt to income ratio, they may allow up to a 45% ratio. That allows them to loan to these high quality borrowers who cannot meet QRM guidelines. And since industry experts estimate that the costs for a non QRM mortgage could be 3 times as high as for a QRM, the mega banks and portfolio lenders can earn a high premium for cutting these solid borrowers a little bit of a break.
Loans made to Fannie and Freddie are to be excluded from the risk retention provisions as long as Fannie and Freddie remain in conservatorship. However, Cunningham's testimony raised the excellent point that we have no reason to believe that Fannie Mae and Freddie Mac will have looser guidelines than those stated in the QRMs. In fact, if the two agencies follow their usual course they will have tighter guidelines than the QRMs since both Fannie and Freddie are being phased out and are currently being charged with reducing their portfolios.
The comment period for the current proposal for Qualified Residential Mortgages ends June 10. It is imperative that the FDIC receive as many comments on this issue as possible. Make no mistake--the QRM guidelines being presented by the FDIC will shut the majority of Americans out of the possibility of home ownership and will turn creditworthy people into life-long renters. Homeownership is one of the greatest wealth building tools that we possess as a nation, and to deny middle class and upper middle class families access to credit is wrong. Speak up today before these guidelines are published into a final rule.
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