The term “qualified residential mortgage” is about to become very important to the mortgage industry.
Its guidelines may determine what a “good” mortgage is for the private mortgage market. As the Obama Administration has proposed winding down the public sector’s involvement in mortgage making, all eyes have turned to what kind of a player the private markets will become.
When the Dodd-Frank Act went into effect last year, it included a provision that lenders dealing in mortgage-backed securities must retain 5% of the value of those mortgages. This risk-retention rule ensures that—unlike during the boom years when banks passed all the risk onto investors—lenders would have some skin in the game.
However, there are some exceptions. FHA loans are exempt from the risk-retention rule, and new regulations will include exemptions for all federally backed mortgages, according to the Washington Post. In the private sector, the exemption is extended only to securities made up entirely of “qualified residential mortgages.” That provision will make these securities far more desirable for lenders, ultimately influencing what mortgage products are brought to the market.
What counts as a qualified residential mortgage remains to be seen. The bank regulators, Securities and Exchange Commission, Federal Housing Finance Agency, and HUD are currently hashing out the guidelines, which are expected to be revealed sometime in the next couple of weeks.
But for starters, Dodd-Frank states that the agencies must take “into consideration underwriting and product features that historical loan performance data indicate result in a lower risk of default,” including:
- Documentation and verification of the financials used to qualify the borrower
- Income and income-to-payment ratios
- Mitigating payment shock on ARMs
- Mortgage insurance, other insurance, or credit enhancement
- Limiting or banning balloon payments, negative amortization, and other options known to increase the risk of default
Speaking with sources familiar with the agencies’ discussions, the Washington Post also reported that two plans are being discussed, one that would require a 10% down payment and another that would require 20% down.
The plan already has its detractors. Ellen Seidman, former director of the Office of Thrift Supervision and a member of the Mortgage Finance Working Group sponsored by the Center for American Progress, argues that high down payments would push too many credit-worthy buyers out and consolidate all borrowers looking for a low down payment option into the public sector.
“You would lock out of homeownership a huge percentage of renters and a disproportionate percentage of minority renters, except perhaps through FHA,” Seidman says. “The problem there is that you move all the risk onto the government.”
She points to 2004 U.S. Census data showing that while 25.1% of white, non-Hispanic households had a household net worth of less than $10,000 during that period, among black households the percentage increased to 50.7% and among Hispanics it was 47.6%. “These are all households, not just renters,” she notes. “For homeowners, net worth includes home equity.” As the current median house price is about $170,000, a 10% down payment would be $17,000, far above the reach of many minority families. “Unfortunately the last good data we have is several years old,” she says. “With the recession, we know that things have only gotten worse.”
What’s more, she argues, the vast majority of the time, the size of the down payment is not a good indicator for risk of default. “For well underwritten and well structured mortgages, the size of the down payment, once you get past a very small amount, is not a particularly robust indicator of default,” she told Builder. “There is a linear relationship [between down payment size and default] but other characteristics of the mortgage are far more important.”
Patrick Newport, U.S. economist at IHS Global Insight, disagrees. “In a market with rising house prices, it may not be a driver,” he wrote in an e-mail to Builder. “In a market with falling house prices, it matters.”
Newport foresees homeownership rates dropping another 2.5% to an average of 64% over the next few years as tighter lending standards are put into place. Even so, he thinks the change will be positive. “Shifting risk to lenders is an incentive for them to be careful in issuing loans,” he says. “Better written loans are in nearly everyone’s interest.”
Claire Easley is senior editor, online, for Builder.
Learn more about markets featured in this article: Greenville, SC.