Though the new "ability to pay" (aka Qualified Mortgage or QM) rules released last week by the Consumer Financial Protection Bureau drew extensive media coverage, there are still widespread misunderstandings about how they’ll work in practice. That probably shouldn’t be a surprise since the regulations weighed in at a chunky 804 pages.
So what are the rules going to mean for real estate professionals and their clients? Here’s a quick overview of a few issues of concern. Start with the potential impacts on underwriting during 2013, well before they officially take effect next January.
Will lenders finally begin loosening up a little? After all, since 2010 they’ve been telling us that one of the key reasons for their ultra-strict underwriting is the "regulatory uncertainty" flowing out of the Dodd-Frank financial reform legislation — the risk that federal agencies will impose new mortgage rules that open banks up to costly lawsuits by defaulting consumers.
Well, now they’ve got their once-feared regulation, and it creates a broad "safe harbor" that essentially shields them from such litigation nightmares if they simply follow the guidelines. Will they loosen up?
The day the QM rules were released, I asked David Stevens — chairman and president of the Mortgage Bankers Association, former FHA commissioner and former head of Long & Foster Real Estate, the largest independent realty brokerage in the U.S. — that very question.
Stevens could not have been more emphatic: " I completely disagree" that the QM rules will ease any standards, he said. And in fact, "I think on the margins, things will be a tad tighter."
What? Why tighter? Just about all lenders already follow the QM basics — full documentation of applicant’s income, assets, employment, credit history — so why would lenders even think about getting more restrictive?
Because, said Stevens, the rules also create new quality control requirements for lenders that add to costs, as well potentially severe financial risks if they make a mistake and approve a loan outside the QM parameters for safe harbor treatment.
Plus the Dodd-Frank law limits total points and fees for qualified mortgages at 3 percent of the loan amount, including fees paid both by the borrower and lenders to loan officers. That could negatively impact large lenders, home builders and realty brokerages who use affiliated companies for certain loan-related services — title, settlement, appraisal among others. Now, they’ll somehow have to cram originator/ broker compensation and the affiliates’ fees into deals to pass the 3 percent test — if they can.
Though the CFPB says it’s open to suggestions on how to handle computation of the 3 percent cap, the entire issue is troubling to wholesale lenders and big banks that own highly-profitable affiliates. It does nothing to encourage them to loosen up on anything. To the contrary, under current practices, they don’t have to worry about this stuff at all.
So expect no underwriting favors for your buyers this year. Lenders aren’t in the mood.
Also worrisome, according to Stevens, is the rule’s treatment of jumbo mortgages, which are crucial financing tools for buyers in higher-cost market such as California, Hawaii, metropolitan Washington D.C., New York and parts of New England.
Under the CFPB regulations, to achieve QM safe harbor protection, a loan generally must not have a "back end" total debt-to-income (DTI) ratio in excess of 43 percent. Stevens estimates that 22 percent to 25 percent of all jumbos — loans that exceed the Fannie Mae-Freddie Mac conventional loan limits — have DTIs beyond that cap, and many others come with interest-only payment terms to limit borrowers’ monthly outlays.
But the Dodd-Frank law, and the new rules, prohibit interest-only features in loans that get the QM stamp of approval. Since the jumbo market lacks the strong secondary market support of Fannie, Freddie and Ginnie Mae, lenders are expected to avoid all non-QM loans. As a result, buyers in upper-cost areas can expect worse treatment looking ahead: Even larger down payments and much more rigorous underwriting scrutiny.
Already, California’s U.S. senators, Barbara Boxer and Dianne Feinstein, have written to the CFPB warning that its rule, at least in current form, "would have a disproportionate impact on California and other high cost states, potentially limiting access to affordable credit even more." They asked CFPB director Richard Cordray to review the jumbo situation and try to lighten up on the harsh treatment.
At least for the near future, there will be some flexibility possible for the large numbers of prospective home buyers who cannot meet the mandatory 43 percent DTI test. As long as their loans can get green lights from the automated underwriting systems of Fannie Mae (Desktop Underwriter), Freddie Mac (Loan Prospector), FHA’s "Total" overlay underwriting system or from the VA, they will be eligible for QM status even if their DTI’s exceed the 43 percent limit.
This will continue to be the case for as long as Fannie and Freddie remain in conservatorship — but no longer than seven years — or until FHA and VA adopt their own QM rules.
Since FHA and VA loans frequently have back-end DTIs above 43 percent, this will keep the door open to some, but not all, borrowers who need special considerations on credit defects and other issues in their applications. However, since automated underwriting approval will be required, manual underwriting may no longer get them in the door.
Some other provisions in the rules that could affect your business:
- Seller-financed notes and mortgages, which can provide creative solutions to a wide variety of buyer incapacities, will not be affected by the federal QM regulations at all. There will be no restrictions on the terms, rates or payment features that home sellers can offer purchasers who might not be a candidate for a bank loan. However, sellers who make more than five such notes during the course of a year will not qualify for this exemption.
- Subprime loans in the QM era? Not a chance from major financial institutions. Those folks will either have to find a way to qualify under FHA’s rules — which may be increasingly unlikely since FHA is toughening, not relaxing, credit standards and raising fees — or just not become home buyers at all.