New Mortgage Rules May Discourage Return of Private Lenders
Legislation has recently gone into effect that will dramatically tighten up the mortgage market. Following the housing crisis, Congress passed the Dodd-Frank law that requires lenders to retain a part of the risk on the mortgage loans they make, with the intention that this will prevent any repeats of the catastrophic meltdown with which we are still dealing.
The legislation left room for a loop hole, however. Lenders will not have to hold on to that 5 percent of a loan, or risk retention, if they sell a "qualified residential mortgage" to investors. Until this past week, the term had not been defined; it was to be essentially a home loan safe enough to negate the need to "insure" it.
Now that the rules are in effect, a group of regulators this week made a decision about the definition of "QRMs". These will be mortgages where the borrower puts down at least 20 percent of the loan value, provide full income and asset documentation, and have very low debt-to-income ratios. Previous 60-day delinquencies on any loans (including auto loans and credit card accounts) will disqualify borrowers from this category.
This definition is fitting for "safe" loans. Such stringent requirements will definitely ensure that QRMs have very little associated risk. And for loans that do not meet this standard, the lenders will have to retain 5 percent, giving them incentive to only make loans they think will be sustainable.
Some believe these new rules will scare off all private lending though, saying that no one would invest in mortgage loans if they have to shoulder some risk.
"By mandating a 20 percent down payment on qualified residential mortgages, the administration and federal regulators are excluding those without huge cash reserves — which constitutes most first-time home buyers and many middle-class households — from a chance to buy a home," said Bob Nielsen, chairman of the National Association of Home Builders.
While it true that most lenders these days are used to selling off every penny of the mortgages they make, it is not an absurd concept to expect them to take on some risk. The business of lending by definition involves all sorts of risk and in the old days, banks held all their home loans on their own books.
Besides, "economic incentives," says FDIC chairwoman Sheila C. Bair, "are the best check against lax underwriting standards."
She contends that "QRM loans will be a small part of the market" and that the private market should step up to fill in the rest.
The private mortgage market has yet to resurface on a normal scale though, and it may take some coaxing for that to happen. Hopefully, investors will feel better about buying home loan securities now that they know lenders have to have some "skin in the game."
However, until the government role in the market is significantly reduced, we may not see much revival of private lenders. Fannie Mae and Freddie Mac guarantee roughly 95 percent of all new loans these days. There is talk of increasing their fees and cutting the size of mortgage they can insure, but as long as it remains attractive to sell to Fannie and Freddie, there will not be much more capital flowing through the mortgage market.