With the January implementation of the qualified mortgage rule, there has been confusion about which borrowers will and will not be impacted by the new restrictions. While the rules will push some borrowers outside of its safer-status for lenders, possibly restricting access and raising borrowing costs, the vast majority of borrowers will qualify for the safer “QM” status. The comprehensive scope of the final rule is important for a healthy transition for the housing market and access for most credit worthy borrowers and should be adopted in another forthcoming rule, the qualified residential mortgage rule (QRM).
The qualified mortgage (QM) rule and ability to repay (ATR) rules were implemented in January of 2014. They are only two of several rules that came from the Dodd–Frank Wall Street Reform and Consumer Protection Act that will impact the housing market. The ATR rule is intended to protect consumers through stronger underwriting standards by requiring full documentation of income, assets, employment and the ability to repay for all mortgages. Lenders have voiced concerns that the ATR definition is not definitive enough, leaving them exposed to risks and legal costs of not complying with the ATR. These costs are significant and tough to budget for. Consequently, regulators created an exemption called the qualified mortgage rule where lenders get clear though stricter rules that they must comply with and in doing so, their legal liability is better defined and limited. The features of these safer QM loans include a maximum of 3% for points and fees, a cap of 43% on the back-end debt-to-income ratio, and limitations on the type of mortgage products that qualify and prepayment penalties among other requirements.
The 43% back-end debt-to-income requirement could have a significant impact on the market, though. Researchers at Goldman Sachs estimated that 14% of mortgages originated by Freddie Mac in 2013 would not have met this requirement, while only 5% of prime, jumbo loans that were securitized had a DTI greater than 43%.
These figures corroborate statistics from 2010 that were analyzed by the Federal Reserve. Mortgages with back-end DTIs greater than 43% accounted for 13% of the GSEs purchases, but 27% of Ginnie Mae and Farmer Mac. They also accounted for 20% of private securitizations and 25% of bank holdings, but these two holders were a much smaller share of the market. Given that the government finance sources accounted for nearly 90% of the market in 2010, the 43% restriction would have affected nearly a fifth of the market.
However, the CFPB chose to include in the QM definition mortgages that are eligible for purchase by the GSEs, USDA, VA or the FHA, even mortgages with back-end DTIs greater than 43%. This inclusion holds for as long as the GSEs are in receivership or 7 years. The FHA has its own definition of QM and the USDA and VA are expected to create their own definitions as well. Furthermore, the FHA’s and GSE underwriting incorporates compensating factors. Thus, when a risk factor like the DTI rises, a stronger score in some other underwriting factor offsets that risk.
This “patch” will prove important as the market adjusts to the new regulation. Contrary to what one might imagine, higher DTIs are not just utilized by first time buyers. As depicted above, the share of repeat buyers financed through the GSEs with back-end DTIs greater than 43% is significant and not too different from first-time buyers. Economist Scholastica Cororaton looked at the generational impact of a strict 43% restriction and the interaction with growing student loan debt in more detail for a recent report. Thus, this important patch will allow lenders and consumers time to adjust to the new rules over the next seven years and leaves a window for change if need be.
However, another rule set to be finalized this spring could undo this important patch. The risk retention rule from the Dodd–Frank Wall Street Reform and Consumer Protection Act was intended to protect investors by requiring issuers of mortgage backed securities to retain a portion of the MBS that they issue so that they would have “skin in the game”, sharing in the risk of their product. Holding back capital in this way raises the cost to the issuer which is passed onto the consumer, though. Consequently, to protect both investors and consumers, an exemption to this risk retention rule was created called the qualified residential mortgage (QRM) rule where low risk loans could be securitized without risk retention avoiding the added costs for lower risk borrowers.
Regulators have proposed to make this QRM rule the same as the QM rule. However, an alternative QRM proposal would impose a 30% down payment requirement in addition to compliance with the QM, add restrictions based on credit history, and it would eliminate the important patch for mortgages eligible to be financed through the GSEs or government sources, which would impact all borrowers with a back-end DTI greater than 43%. While private securitizers and banks hold some loans with higher DTIs, they often impose significantly larger down payment requirements, higher FICO requirements, and larger reserve requirements than the GSEs or FHA and without the QM status they might be less likely to purchase these mortgages or they will charge much higher rates. Thus, the QRM alternative would have a significant impact on access to credit and likely drive up costs for a much broader portion of the market.
The new qualified mortgage rule introduced widespread changes in the housing finance industry, changes that will benefit the consumer. However, in the near term there will be a learning process and the CFPB has adapted important changes that allow for effective risk management while supporting the market and protecting consumers.