Your mortgage experience is about to changeby Peter Miller
How will you finance or refinance your home the next time you’re in the market for a mortgage? For a lot of borrowers the experience is likely to be very different than in the past. Not only that, it may also be different for a lot of lenders.
The government is now in the process of defining what is and what is not a qualified residential mortgage (QRM). This definition is required under the Dodd-Frank Wall Street Reform Act and apparently is quite complex: The government’s proposal runs 376 pages, little of which can be understood without an advanced degree.
You’ll hear a lot online and in the media about new mortgage standards and the possibility that borrowers will need 20 percent down to buy a home and 25 percent equity to refinance. What you won’t hear a lot about is why lenders are lobbying to design regulations to their liking.
To understand what’s going on, let’s start with the toxic loans that are at the heart of the mortgage meltdown.
The head of the Federal Deposit Insurance Corporation, Sheila Bair, explains that new rules are needed:
“Almost 90 percent of subprime and Alt-A originations in the peak years of 2005 and 2006 were privately securitized. During that period, the separation of originating and securitizing loans from the risk of loss in the event of default fed a massive amount of lax, unaffordable lending which fueled the housing bubble. Since neither lenders nor securitizers appeared to hold any real risk in the transaction, the ‘originate-to-distribute’ model of mortgage finance misaligned incentives to reward the volume of loans originated, not their quality. The consequences for our economy have been severe.”
Translation: Lenders were making incredibly-risky loans and Wall Street was buying them like donuts to create mortgage-backed securities that yielded enormous profits. If the loans were lousy, so what, the lenders and Wall Street claimed that they were somehow out of the picture and not responsible for anything.
The idea behind Wall Street reform is to keep lenders and Wall Street–the “securitizers” to which Bair refers–financially on the hook. Under Dodd-Frank, lenders have to keep a 5 percent reserve for risky home loans, though one commentator suggests that 10 percent would be a better reserve for risky loans. Lenders, of course, would prefer no reserve requirement because money set aside in reserves is money which does not maximize profits.
But what are risky home loans? Those would be any mortgages which are not QRMs.
Dodd-Frank sets out a series of core requirements for mortgages and it also says that federal regulators can fine-tune the standards. A lender who only issues QRMs has a safe harbor and does not need to keep a 5 percent reserve, and also has little chance of being sued by borrowers under provisions of the legislation.
The good news is that loans which meet Fannie Mae and Freddie Mac standards, as well as VA and FHA loans, are automatically qualified residential mortgages. This means you will be able to buy real estate with far less than 20 percent down, regardless of what financial fear mongers might say. Of course, QRMs would have lower average mortgage rates than more-risky financial products.
Under the proposed QRM definitions, a qualified residential mortgage would have to meet a series of standards. For instance:
- Interest rates on adjustable rate mortgages would only be allowed to increase 2 percent annually and 6 percent over the life of the loan. (Page 284)
- Negative mortgage amortization and interest-only financing would be banned. (Page 284)
- Borrowers could not have a 30-day late at the time of application. (Page 283)
- Borrowers would not be allowed to be 60 days late during the past 24 months. (Page 283)
- Borrowers would not qualify for financing if they had a foreclosure or short sale during the past 36 months. (Page 283)
- Traditional conventional loan ratios would apply: No more than 28 percent of monthly income can be used for housing expenses and no more than 36 percent for all recurring monthly debts. (Page 138, 285)
- The 20 percent down payment would be based on the appraised value or the purchase price, whichever is less. (Page 287)
In effect, what’s being proposed is largely a return to the traditional lending standards in place before the year 2000, what one might call the good old days (you remember, when both lenders and homeowners were largely solvent).
Peter G. Miller is syndicated to more than 100 newspapers and operates the real estate news site, OurBroker.com.