Wednesday, January 23, 2013

Qualified Mortgages, Loan Originator Compensation and the Law of Intended Consequences

We are getting used to massive federal changes at the beginning of each year.  Last January, we saw President Obama's controversial recess appointment of Richard Cordray as the first permanent director of the Consumer Financial Protection Bureau.  (The appointment was controversial because the Senate was not actually in recess at the time.)  This year we are seeing the new qualified mortgage rules and the 3% cap on loan originator compensation.  These rules are mandated under the Dodd Frank bill, passed in 2010, and we have been waiting now for two and half years to see the final versions.  Now, this month, the CFPB has rolled both out, along with other new housing regulations.

With the nation's attention turned to the president's second inauguration, the battle over the budget and debt ceiling and a growing fight over gun control, new mortgage rules barely have made a blip on the national radar.  The morning that the new qualified mortgage rules were introduced, the local ABC affiliate in El Paso carried the story that new mortgage rules were being introduced.  "This should cause banks to start lending again," the local morning show anchor added optimistically.  Other press releases from non-industry sources seemed to indicate that the new rules would provide the certainty that the market needs in order to commence mortgage lending again.

Of course, those of us who work in housing know that nothing could be further from the truth.  David Stevens, former Assistant Secretary of HUD under President Obama, who left his position to become President of the Mortgage Bankers Association, said bluntly that the new standards will do nothing to loosen credit and in some interviews he went on to add that the new standards will actually tighten credit.  That is a more realistic picture of what is going to happen.  Where Stevens and I disagree is how much the new standards will tighten credit--he appears to believe that there will be a slight tightening while I predict that ultimately, the new standards will make mortgage credit much more difficult to obtain.

Why?  As industry participants have pointed out, the new standards are much less restrictive than the original proposal.  For example, the new qualified mortgage calls for debt to income ratios at 43% rather than the originally proposed 36%, and loans which are being sold to Fannie Mae and Freddie Mac and government loans are automatically in the safe harbor so their debt-to income ratios can remain higher.  Also, the final rule allows for smaller downpayments and equity requirements than the 20-30% minimum initially suggested.  So why am I pessimistic?

First of all, we must consider the climate in which this rule was created.  Sheila Blair, former chair of the FDIC who worked on the qualified mortgage concept, said initially that the qualified mortgages were meant to be a very small slice of the mortgage market.  If a borrower receives a mortgage that does not meet the qualified mortgage standards, the borrower can use the lack of "ability to repay" standards to forestall foreclosure almost indefinitely, and the lender may be required to repay three years of finance charges to the borrower.  That is a powerful incentive to originate only qualified mortgages.  As Stevens properly mentions in some of the interviews I read, the trend is going to be to begin underwriting according to these standards before they are actually mandatory next January.

Any mortgages sold to Fannie Mae and Freddie Mac are considered to be covered under the safe harbor provisions, but we have watched both Fannie Mae and Freddie Mac consistently tighten their own underwriting standards.  I predict that prior to the effective date of the new rule in January of 2014, both Fannie and Freddie will have adjusted their automated underwriting systems to accept a maximum debt to income ratio of 43% and to comply with the downpayment standards of the new rule.  Don't be misled; the qualified mortgages may not officially become effective until next January, but the industry is going to begin using these standards this year in preparation for their full implementation 12 months from now.

Many housing professionals are concerned about the impact of the new rule on the jumbo housing markets in higher cost places such as California and Nevada.  Tighter credit standards are going to negatively impact the market.  Most probably the major impact will be that housing prices will fall again in these states as borrowers struggle to qualify with the new guidelines.  This is particularly true since the qualified residential mortgages do not allow homeowners to qualify with interest only payments.

Finally, there is the 3% cap on points and fees.  There still appears to be some confusion about what this covers exactly.  Fees include lender fees, originator fees (including yield spread premium) upfront private mortgage insurance on conventional loans (though not on government loans) attorney fees in states that require that attorneys prepare the documents, title and third party fees when affiliates companies are used, and in some cases appraisal fees. 

Last night I watched a video by the National Association of Mortgage Brokers explaining the loan originator compensation rule introduced on Sunday January 20.  NAMB's Government Affairs Chair, John Hudson, stated that by writing the 3% rule as it has, the CFPB is picking the winners and the losers, favoring large Wall Street banks over the small business owners.  He stated that since the CFPB is unwilling to look at the impact of the rule on small business owners, we need to try to fix this problem legislatively as he does not believe that the intent of Congress when they passed the Dodd Frank bill was to restrict access to credit and to discriminate against small business owners.

As far as I am concerned, this whole conversation is wrong on so many levels.  First of all, to have national underwriting standards codified into law is ridiculous.  Lending is based on risk and reward.  Just as we should never bail out failing firms--failure is part of risk--we also should not have national legal standards for mortgage loans.  Such standards do not allow for underwriters or investors to make any decisions for the individual borrower's situation.

Second, the intent of Dodd Frank and all of its resulting rules IS to limit access to credit and to pick winners and losers.  When Mitt Romney stated that Dodd Frank was the biggest "kiss" the Wall Street banks ever got, he spoke the exact truth.  Every inch of the Dodd Frank bill benefits Wall Street at the expense of everyone else. The major banks can afford to salary their employees and since the money that they make selling their loans on the secondary market is specifically excluded from the 3% points and fees cap, they do not have to worry about staying in compliance.  A mortgage broker, on the other hand, who is paying all of his own brick and mortar expenses and originating loans may be forced to reduce his fee to 1% or less to comply with these requirements.  And since the advent of lender paid compensation and lender contracts, we cannot vary our compensation from loan to loan, so we will have to reduce our fees on all loans in order to stay within the 3% guideline.  (There are provisions for smaller loans under $100,000 to exceed the 3% cap, but that will not help the loan originator much since the lender paid compensation is a set percentage of the loan.)  In a tight market, more fee reductions simply mean that smaller originators cannot earn enough money to pay their expenses and keep their doors open.

Many in our industry are calling this "the law of unintended consequences."  In an effort to protect consumers, Congress passed a bill that will cut off competition, limit access to credit and prevent consumers from having lending options. Again, I disagree.  This is the law of completely intended consequences.  Remember that Dodd Frank was passed by a Democrat house and Senate and named for the extremely liberal Chris Dodd and Barney Frank.  The liberal agenda of the past four years is not to promote home ownership--instead it is to promote sustainable living as our government transitions us from a society of home owners to a society of renters living in sustainable housing.  We know that this was particular goal of Chris Dodd because the last bill he sponsored before he retired was the "Livable Communities Act," which did not pass but which would have created federal frameworks for implementing Smart Growth and Sustainable living initiatives.  The problem with making such a transition is that home ownership has traditionally been the American dream, and many Americans are not willing to just abandon that dream in favor of a lifetime of living in crowded, tiny multi-family housing.  Micro apartments such as the ones Mayor Bloomberg is commissioning in New York--for more information see the post Dream Small--may find willing residents in the Big Apple, but in the rest of the country we want a house.

Very simply, in order to move toward the radical environmental agenda of tiny apartments and densely populated housing demanded by environmentalists and called for in Agenda 21, the government has to cut off other housing options.  Access to credit gives Americans options to buy and sell housing and to live where they choose. By cutting off access to credit and limiting the availability of loans, the government can continue its current trend of rebuilding our society into one without a middle class--a society where the rich become richer and the poor stay poor.  And since home ownership has been one of the defining characteristics of the middle class, Dodd Frank had to attack it at its foundation--access to and availability of mortgage credit for a majority of Americans.

Anyone reading this who wants a private home and can qualify for one should consider buying in early 2013.  After these rules are fully implemented, buying, selling or refinancing is going to be much more difficult.  And with each month that passes we are moving closer to the remaking of our society.

Alexandra Swann is the author of No Regrets: How Homeschooling Earned me a Master's Degree at Age Sixteen and several other books. Her novel, The Planner, about an out of control, environmentally-driven federal government implementing Agenda 21, is available on Kindle and in paperback. For more information, visit her website at


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