Dodd Frank--Protecting You Right into an 11% Mortgage

On December 19, 2013, I sold the office building which for 10 and a half years had housed my mortgage company. The closing was held at a "fee office" for one of the local title companies--this particular fee office is operated by a local real estate attorney who handles a lot of transactions for the local lenders. As we signed the closing docs, he chatted pleasantly about the surge in private equity lending that is happening and he expressed surprise at the quality of borrowers who are now using private money lenders rather than traditional mortgages. "You look at some of these people--they have great credit and great income and you think, 'Why is this guy taking an 11% mortgage?' But they do."

I left that closing and that conversation very sure that my decision to exist the loan origination industry nine months ago (on my company's fifteenth year anniversary) had been exactly the right one. In July of 2010, when Obama and the Democrats pushed through the Dodd-Frank bill--with the help of four Republican Senators--the bill was touted as a consumer protection bill that would prevent any more bailouts and end "too big to fail," as an excuse for squandering taxpayer's money. Three and a half years later we know for certain that none of those promises was true. None of the "too big to fail" issues has been addressed at all. What has happened is that the 858 page bill with its 398 regulatory requirements is generating massive new regulations that are squeezing ordinary consumers out of credit markets completely. So far, Dodd-Frank has generated 42 words of regulation for every word of text in the original bill, and only about 50% of the regulations have been written. Sixty-three percent of the regulatory deadlines have been missed. As with its big government counterpart Obamacare, it has delivered none of what it promised. What it has delivered is an enormous new bureaucracy in the form of the Consumer Financial Protection Bureau which has no Congressional oversight. Housed in Janet Yellen's Federal Reserve, the CFPB answers to no one but the president, but the agency has unprecedented powers not only to regulate and even close private businesses, but also to monitor and spy on Americans down to the last dollar in your bank account and that cup of coffee you charged on your credit card yesterday at Starbucks. This is the agency responsible for getting rid of all of the bad lenders and the bad mortgages and making sure that every consumer is treated fairly every time.

Part of this new regulatory landscape includes four thousand pages of new mortgage regulations. Two of the most anticipated (or maybe that word should be "dreaded") deadlines come this week: on January 10, the qualified mortgage rules and the ability to repay rules will both take effect. This is a deadline many mortgage lenders were hoping to miss, but repeated calls from the industry to CFPB director Richard Cordray for a stay of these rules were ignored.

The qualified mortgages provide strict guidelines for lenders in making residential mortgage loans. The consumer must have demonstrated an ability to repay, his or her total percentage of debt to income cannot exceed 43%, and the total points and fees on the loan cannot exceed 3% of the loan amount. The APR of the mortgage loan cannot be more than 1.5% above the annual prime rate. As long as lenders comply with these mortgage guidelines, they are protected, though not shielded completely, from borrower lawsuits alleging misconduct.

Loans that do not meet these strict standards may qualify for a higher cost mortgage that still offers some protections under the ability-to-repay rule. If the lender has demonstrated that the consumer has the ability to repay the mortgage and that the total debt to income does not exceed 43% of the borrower's verified income, the lender can still argue that they have acted in good faith. Loans that fall outside of these boundaries are non-qualified mortgages. On a non-qualified mortgage, the lender must retain at least 5% of the loan for the life of the loan without ever selling it. In addition, if the borrower proves in court that his rights were violated, the lender has to pay back all of the interest and fees to the borrower and cannot ever foreclose. On a $200,000 mortgage, the lender would have to permanently retain at least $10,000 of the mortgage for the life of the loan--something many institutional lenders are not in a position to do. These are very high risk loans for the lenders, so they are going to be very expensive for the consumers. Since most banking entities are not going to take on this much risk, these loans will fall to private lenders who are willing to take the risk in exchange for an 11% interest rate and high fees. In addition to your local private money lender, Wall Street hedge funds are exploring the possibilities of making non-qualified mortgages because of the high yields in the form of interest rates and fees. (But wait--I thought hedge funds were among the evil entities the government wanted to stop.  Perhaps not.)

The attorney who was visiting with me said that he had made numerous phone calls to the CFPB in helping his clients get into compliance on the new rules. At first they were very responsive, but now they have "gone dark" on him and no longer return calls. The CFPB is apparently not very interested in providing regulatory guidance to those seeking to comply with the new rules. Why would they be? They have just written 4000 pages of regulations that will ultimately be interpreted by the courts. And in the meantime, they can order audits, including IRS audits on practically any lender, large or small, and impose fines and fees without restriction on anyone who violates the new rules.

The Obama Administration is pretending that the qualified mortgages will not restrict lending. They optimistically hope aloud that lenders will be flexible in their lending guidelines and that they will continue to look at loans on a case-by-case basis. The problem is that Dodd Frank's guidelines do not allow for this. As Jeff Taylor, managing partner of Digital Wire, points out frankly in Housing Wire, Dodd Frank "draws a hard line in the sand and removes all subjectivity so that lenders cannot consider compensating factors." That means that your lender no longer has the power to say, "you might be a little bit outside of the box, but you are still a good loan."

Bloomberg is reporting today that Wells Fargo projects that 40% of their loans will not meet qualified mortgage standards, and they have created a SWAT team of 400 underwriters to underwrite the loans they decide to portfolio themselves.   We can expect that Wells will price these loans considerably above the QMs but enough below the hedge funds and private investors to scoop up the choice borrowers who no longer qualify for optimal financing.

So who are the losers in this?

1. Consumers who don't quite fit into said tiny, narrow box. Mark Savitt, former president of the National Association of Mortgage Brokers, current president of the National Association of Housing Independent Professionals and a long-time mortgage veteran in West Virginia, is reporting that problems have already begun. In the Mortgage Professional's Association newsletter, Savitt explains that one of his borrowers was just declined by Fannie Mae for a mortgage loan because she was exceeded the guidelines of the qualified mortgage. (Even though the official start date is Friday, in practical terms lenders began using these guidelines weeks ago because of their deadlines for selling to Fannie Mae and Freddie Mac.) This woman, who has been on her job for twenty years, has a 732 credit score and was making a $79,000 downpayment on her new home purchase. She was financing only $50,000, but because her debt-to-income ratio was 47%, Fannie Mae declined the loan as being "high risk." As Savitt explained, the only way she is going to get that loan now is to get a non-qualified mortgage with considerably higher points and fees. Her cost of borrowing has just gone way up because of Dodd Frank's consumer protections.

2. The self-employed. The ability to repay provisions greatly favor W-2d employees. For the self-employed mortgages, are going to be increasingly more difficult to obtain and increasingly expensive if they can be obtained at all. Before I left the industry I began to see institutional lenders setting guidelines that would not accept any of a borrower's income if the income had decreased over the last two years. If you are one of those few lucky individuals who owns a business that has made more money over the last two years than in the past, I congratulate you heartily. If not, you are probably not going to qualify for a "qualified mortgage."

3. Sellers. All sellers. Why? If you want or need to sell your home, you need to find a borrower who can actually qualify to get a mortgage loan so that you can move on. Being able to sell your house may mean the difference between being able to relocate to a new city or being able to move to a new job across country. If your situation is dire enough, it may even be the difference between foreclosure and keeping your credit in tact. Cutting off access to mortgage credit can have major impacts on the society as a whole.

Who are the winners?

1. Wall Street. Wall Street can price the risk for these non-qualified mortgages into the new loans and they can afford attorneys to keep the homeowner tied up in court for years.

2. Big government. Unlike Obamacare, Dodd Frank does not have widespread public outrage. The government can sanctimoniously tell consumers that it is protecting them from "bad mortgages" they can't afford with very little opposition. And they can use the fines and fees they are extracting from businesses to continue to grow an agency whose average salary is six figures--all in the name of "saving the people."

3. The leftists in our society who increasingly fight property rights because private property ownership does not fit well into their new vision of what America should be. These activists want to see an end to single family homes, suburbs, private automobiles, and all of other traditional amenities of our society because our way of life is not eco-friendly. Their ultimate goal is to see all Americans living in densely-packed rental housing and taking public transportation. The qualified mortgage is just the first step.

When the mafia extorts money from you to allow you to live, they call it "protection money." When the government does it, they call it "consumer protection." Either way, you are paying for protection from someone who has the power to take everything you have.