New mortgage rules may crimp lending, but should build investor trust

CoreLogic: Return of private capital hinges on confidence in lending process

While some say new mortgage rules scheduled to take effect on Jan. 10 could crimp lending, the rules are key to building private investors’ confidence in the secondary market, according to a white paper released today by real estate data and technology firm CoreLogic.

“Setting the rules and boundaries for consumer mortgage loans is one of the first steps needed to encourage more private capital investment in the housing finance system,” the paper said.

“Uncertainty of investor appetite for credit risk and litigation risk under the new rules persists, but the new rules provide a foundation to build investor trust in the system over time.”

Under “ability to repay” and “qualified mortgage” rules first announced earlier this year, mortgage lenders will be required to ensure borrowers don’t take on more debt that they can afford by evaluating them on eight underwriting factors, including current income and assets, credit history and monthly payments on the mortgage.

Amendments to the ability-to-repay rule will exempt certain nonprofit and community-based lenders who work with low- and moderate-income homebuyers.

A “qualified mortgage” prohibits excessive points and fees (generally, those above 3 percent of the loan amount) tacked on to upfront origination costs; cannot have risky loan features such as a term that exceeds 30 years, interest-only payments that don’t pay down a mortgage’s principal, or negative amortization payments where the principal amount increases; cannot have a balloon payment at the end of the loan term except, under certain circumstances, those made by smaller creditors in rural or underserved areas; and the borrower’s debt-to-income ratio — his or her total monthly debt divided by total monthly gross income — cannot exceed 43 percent.

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Temporarily, loans with debt-to-income ratios above 43 percent will be considered qualified mortgages so long as they meet underwriting requirements of government-sponsored enterprises Fannie Mae or Freddie Mac, or the U.S. Department of Housing and Urban Development (HUD); the Department of Veterans Affairs (VA); or the Department of Agriculture (USDA) or Rural Housing Service.

Although mortgage lenders will be allowed to make non-QM loans, meeting the QM guidelines will create a presumption of compliance and will therefore provide lenders with some legal “safe harbor” from lawsuits.

The Consumer Financial Protection Bureau was charged with drafting and implementing the rules under the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act. The legislation was enacted in reaction to the 2008 financial crisis, which erupted after easy access to credit fueled an unsustainable increase in home prices. In the years before the crisis, lenders often made loans without considering the borrower’s ability to repay because the loans were bundled into securities that were sold to investors.

As the housing market turned, private investors fled the secondary market in droves, and now the vast majority of mortgage loans are backed by the federal government, mainly through Fannie Mae and Freddie Mac.

“A failure to adequately review the borrower’s ability to repay for a sustainable mortgage at the time of origination had serious consequences not only for the borrower, but also for the originators, servicers and the investment community,” CoreLogic said.

The Obama administration has pledged to put private capital back at the center of the housing finance system. In the path toward that goal, making sure a borrower has the ability to repay “is good business,” according to CoreLogic.

“The road map to a sound residential finance marketplace will rest on transparency, accountability and traceability. Validation of consumer data and documentation, including material changes prior to funding a mortgage loan, will lead to more confidence in the process,” the firm said.

While some lenders remain worried about how they will comply with the rules, CoreLogic said those concerns would be resolved through “common sense” and, in the end, “the markets will have confidence that the information and processes established to make a sound loan are likely to result in sound loan performance for the life of the loan.”

Concerns also remain regarding whether there will be a market for nonqualified mortgages due to their heightened litigation risk and investors’ possible aversion to non-QM loans, which is expected to drive up their pricing.

“One area of focus will be how to meet the demand of the changing demographics of first-time homebuyers, some with low wealth but less risky credit score profiles, who may have limited options when it comes to the first-time homebuyer programs offered by the government,” CoreLogic said.

The firm asserted that there is ”a nearly unlimited market for those who do not need the ordinary protections afforded the unsophisticated buyer,” however, including housing investors who may not meet QM requirements but still demonstrate an ability to pay.

Overall, the paper’s authors were optimistic about the potential for the non-QM market.

“We have a robust capital market system today, and it’s reasonable to think that a savvy entrepreneur or established organization will figure out a way to deliver qualified and nonqualified mortgages in a way that meets all the regulatory requirements, incorporates sound lending and consumer protections, and makes a profit,” they said.

“Accurate underlying mortgage data, servicer due diligence, and enforceable and consistent representations and warranties will be required for any entity engaging in non-QM lending, but the tools and data are available to make that a reality.”

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