Is the federal government about to make it more difficult for you to get a mortgage? Many people think so. Everyone from consumer advocates and human rights activists to banking industry trade groups to 320 members of Congress fear that an obscure little rule called "QRM" could price millions of Americans right out of the housing market.
"Here's the most important point: the breadth of the groups involved in this coalition," says Glen Corso, spokesman for the Coalition for Sensible Housing Policy, which represents groups as diverse as the American Bankers Association and the National Association of Human Rights Workers. "All the groups involved really see this as a pretty critical issue for credit access and availability." What's This All About, Anyway?
The uproar concerns the government's new definition of what constitutes a totally safe, plain-jane mortgage. Under the Dodd-Frank financial reform act, such safe mortgages (called Qualifying Residential Mortgages or "QRM") can be sold to investors, like always.
But for riskier mortgages, new rules apply. When risky mortgages are bundled and sold as mortgage-backed securities, the people doing the bundling and selling (known in industry lingo as "securitizers") would have to retain ownership of 5% of the loans.
Why? Because under the old rules, mortgage lenders and securitizers made most of their money in upfront fees generated by selling mortgages to consumers, and then reselling those loans on the secondary market to investors. After they sold the loans, they had little reason to worry whether the people living in all those homes could actually afford to pay their mortgages, since all the default risk was handed over to investors.
As we know, many of those loans did fail, throwing the entire economy into the Great Recession of 2007.
The goal of the new rule is to force securitizers to retain some of that risk. If they have some skin in the game, the thinking goes, they naturally will start to care about whether the loans they sell and bundle can be repaid, since they'll be on the hook for 5% of the potential losses.
"The secondary market is wonderful innovation, but it increased risk instead of mitigating it," says Kathleen Day, spokeswoman for the Center for Responsible Lending. "This is intended to tackle the secondary loan market and wrestle it back down to earth."
Almost everybody—federal regulators, bankers, consumer advocates—supports risk retention in principle. It's nailing down the specifics that's getting a little tricky.
"Getting the QRM definition right is vital. Too narrow a definition—limited to loans with very high down payments and high credit scores, for example—could significantly raise the cost of mortgage credit and reduce its availability for a large number of potential borrowers," Mark Zandi, chief economist at the ratings agency Moody's, wrote in a recent report. "Too wide a QRM definition could blunt the risk-retention rule's ability to raise market confidence in securitization."
So Far, So Good
After Congress laid out the framework for risk retention and qualified safe mortgages, six federal regulatory agencies had to agree on what qualifies as safe and what doesn't. The agencies published their proposal on March 29. Under the proposed rules, hopeful homebuyers would have to make down payments equal to at least 20% of the home's value to qualify as "safe." Buyers' mortgage payments would be limited to 28% of their gross income, and their total debts could be no higher than 36% of their income.
The plan would affect current homeowners, too. If the rules are finalized by the agencies in their current form, the rules would require homeowners to have to least 25% equity in their homes to obtain a qualified refinance loan.
The proposed rule is "designed to ensure [qualifying mortgages] are of very high credit quality," according to a press release by the Federal Reserve.
An Overcorrection for A Phantom Problem?
There's no doubt that under the proposed new rules, qualified mortgages would be of very high credit quality.
They also could be very hard to find.
The median home in the U.S. cost $172,900, according to the Center for Responsible Lending. Even if the regulators reduce their down payment requirement to 10% of the home's value, that would still place the American Dream out of reach for millions of working people, the center says, because non-qualified mortgages will be more expensive for banks, and those banks will naturally pass those expenses on to borrowers.
"We think it would unnecessarily raise the cost of homeownership for millions of Americans who are credit-worthy, and push them out of the market," Day says.
The average firefighter would need 10 years to save up a 10% down payment, according to a report by the center. Teachers would need more than 14 years. A staff sergeant in the U.S. Army would need 16 years.
"A 20% down payment across the board is not in my mind necessarily realistic," says Robert Clarke, who served as Comptroller of the Currency under Presidents Reagan and George H. W. Bush.
Besides, low-down payment loans didn't cause the Great Recession, says Mechem. In fact, loans with down payments as low as 3% are performing just as well as traditional mortgages with higher down payment rates, according to says John Mechem, spokesman for the Mortgage Bankers Association.
"We don't understand why the debate is even over setting a minimum down payment, because it wasn't low down payments that caused this problem," Day says.
What was risky, and what actually caused the recession Mechem says, were loans that included "stair-step" interest rate increases, contained large hidden balloon payments, and didn't require homebuyers to prove their income. Such loans were created by lenders and securitizers in the waning years of the housing boom specifically to keep the loan fees flowing by lowering the initial mortgage payments, which made homes more affordable to buy on the front-end, according to the Financial Crisis Inquiry Commission's final report.
The problem, therefore, was never down payments. It was what happened after the down payment was made.
"The loan products that caused this problem—interest-only, negative amortization—we agree to having those in the definition" of a non-qualifying loan, Mechem says.
But tacking on high down payments and tight debt-to-income requirements takes a good idea too far, according to many consumer and industry advocates.
"We believe the regulators went too far beyond the intent of Congress," says Mechem.
Most members of Congress appear to agree. In joint letters to the regulators, 282 members of the House and 33 Senators warned regulators that their proposed rule ignores the "clear guidance" of Congress.
"The proposed regulation goes beyond the intent and language of the statute by imposing unnecessarily tight down payment restrictions," according to one of the letters sent by Senators. "These restrictions unduly narrow the QRM definition and would necessarily increase consumer costs and reduce access to affordable credit."
What Does This Mean For Me?
If the mortgage rules take effect as proposed, only 15 to 20% of new homebuyers would get a "qualified" mortgage, according to the National Association of Realtors. That means securitizers could bundle and sell only 95% of the remaining loans to investors; securitizers would have to keep the rest on their own books. That would increase their insurance and capital costs, restrict how many loans they're able to buy and bundle, which would limit the number of mortgages that lenders could sell.
The result: 75% to 80% of new mortgages would become more expensive, according to research by the National Association of Realtors.
Qualified loans "will constitute the lowest-cost credit that'll be available in the marketplace," Corso says. The rules "will govern who will have access to that low-cost credit and who will have to settle for something else."
The rules would probably increase the average loan's interest rate by 80 to 185 basis points, the Realtors' association found. That translates to tacking between .8% and 1.85% extra onto the average loan's interest rate.
The average interest rate on a new mortgage right now is about 5%. If the rules take effect as proposed, that average could rise to just shy of 7%.
Over the life of a 30-year mortgage, that would cost the buyer of a median-priced house an extra $3,200.
"Non-qualifying loans would be more expensive," Mechem says. "And if you make that bucket of non-qualifying loans too big, you increase the number of people who can't get loans, and it could price them out of the market."
The end result, according to many industry and consumer groups, would be to wrongly classify perfectly safe, credit-worthy borrowers as riskier than they really are.
"A 20% down payment could exclude many consumers who have paid their bills on time, but all of a sudden they find this artificial barrier," Corso says. That's because people who can't afford to put 20% down would find themselves saddled with a higher interest rate, or forced to wait until they can eventually save up the 20%. What Happens Now?
People and institutions had until August 1 to submit comments about the proposed rule. After that, the six federal regulatory agencies will take a number of months to digest the comments and come up with a final proposed rule. With such strong rebukes coming in from Congress, and with lobbying from a coalition of groups that are steadfast foes under normal circumstances (there's no love lost between the American Bankers' Association and the Center for Responsible Lending, for example), it seems likely that the regulators will soften their position.
"That's one of the things that works in Washington," Mechem says. "When you have non-traditional allies like bankers to consumer advocates saying the same thing, it helps a lot to make that argument."
Christopher Maag Credit.com's Staff Writer, Chris graduated with honors from the Columbia University Graduate School of Journalism, and has reported for a number of publications including The New York Times, TIME magazine and Popular Mechanics. Reach Chris via email at chris (@) credit.com.