Financial industry regulators have finalized the risk retention “skin-in-the-game” requirements for mortgage lenders, and industry executives, for the most part, are not happy with the proposed rules unveiled in early April.
The Dodd-Frank Financial reform legislation requires lenders to retain 5 percent of the risk on residential mortgages they originate, but left it to regulators to determine what kinds of loans will be subject to that requirement. Rejecting pleas for maximum flexibility, the regulatory agencies decided that only loans of “very high credit quality” meeting “traditional” underwriting standards will be considered “qualifying residential mortgages.” The key requirements for these loans include:
- Borrowers must make a minimum down payment of 20 percent on a purchase loan.
- Borrowers must not have a 60-day delinquency on any debt obligation within the two years preceding the loan application.
- Monthly mortgage payments can’t exceed 28 percent of the borrower’s income, and total debts can’t exceed 36 percent.
- For refinance loans, the maximum LTV will be 75 percent; 70 percent for cash-out refinancings.
- Only plain “vanilla” loans will qualify as QRMs. Loans with negative amortization, interest-only and balloon payment features, or the potential for large rate increases will not meet the definition.
Industry executives, who tried unsuccessfully to persuade regulators that only the highest-risk loans should be subject to the risk retention requirement, termed the new rules “draconian” and warned that they will limit the availability of credit to a large segment of the population. The overly restrictive standards “could further delay the housing market and have a far-reaching negative implications to the public and investors, as well as for the broader economy,” the Securities Industry and Financial Mortgages Association (SIFMA) warned in a press statement.
Ron Phillips, president of the National Association of Realtors, echoed that warning. "Adding unnecessarily high minimum down payment requirements will only exclude hundreds of thousands of buyers from home ownership, despite their creditworthiness and proven ability to afford the monthly payment, because of the dramatic increase in the wealth required to purchase a home," he said in a press statement.
The new rules do provide considerable flexibility for lenders in structuring the risk they retain. For example, lenders could offset the risk in some cases by holding mortgages identical to those being securitized. The rules would give lenders the option of taking the first 5 percent of a loss or holding 5 percent of every class in a security. Risks could also be apportioned among originators, aggregators and securitizers, subject to some restrictions.
Regulators finessed the controversial question of whether the requirements will apply to Fannie Mae and Freddie Mac. Rumors that the GSEs might be exempt triggered furious criticism from industry executives, who complained bitterly that special treatment would perpetuate the unfair advantage those companies hold and drain much-needed private capital from the mortgage market. The final rules specify that Fannie and Freddie will not be exempt from the risk retention requirement but will satisfy it, because they retain 100 percent of the risk on loans they purchase. Regulators also emphasized that they will review this question once Fannie and Freddie are no longer operating under government conservatorship.
Regulators may also be willing to bend on the strict definition of QRMs. American Banker reported that that regulators are considering two alternative plans: One would create a category of loans subject to a lower risk retention requirement; another would allow more loans to qualify for the exemption but increase the risk retention requirement for non-qualifying loans.
HOUSING HURDLES
Industry analysts have offered a number of explanations for the sluggish housing market recovery, high unemployment and concern about falling home prices, among them. But a major factor may be the difficulty prospective buyers are having obtaining a loan. Lenders are rejecting nearly 25 percent of all mortgages today, according to Federal Reserve statistics. And those numbers don’t reflect the borrowers who hear how difficult it is to qualify, even with decent credit, and so don’t even try.
Reflecting the stiffer underwriting standards lenders are applying, the average credit score on loans purchased by Fannie Mae and Freddie Mac has increased to 760 from 720 a few years ago, and the median down payment has increased from – virtually zero during the boom to 15 percent, the Fed data indicate. The new risk retention requirements will further narrow the market, industry executives warn. “Only the wealthy will be able to buy homes at low interest [rates],” Jerry Howard, CEO of the National Association of Home Builders, told reporters recently.
Those concerns notwithstanding, there have been a few positive signs recently in a housing market that has been almost unremittingly bleak. In one major shift, large single family builders are once again shopping for land, joining a queue that, until recently, has been limited almost entirely to multi-family developers.
“Twelve months ago, there was no Pulte (one of the largest builders in the country) looking at land in this market,” one multi-family developer told Multifamily Executive, an industry trade publication. “Now they’re back again, and I’ve seen these companies pay incredibly high prices.”
A Prudential Real Estate poll spotted another encouraging trend: An increasing number of potential buyers and sellers think the housing market is poised to recover. Sixty-eight percent of the respondents to this poll said they expect the market to recover within the next two years, up from 47 percent who held that relatively optimistic view a year ago.
Prudential analysts think the survey may reflect a “down so long it looks like up” perspective – the market has been depressed for so long, many believe, recovery has to be in the cards.
YSP FIGHT CONTINUES
Federal Reserve rules preventing the payment of yield spread premiums to mortgage brokers are now in effect, although industry trade associations have vowed to continue their fight to block the restrictions on compensation for loan officers.
The new Fed rules, mandated by the Dodd-Frank financial reform legislation, were to have taken effect April 1, but the National Association of Mortgage Brokers (NAMB) and the National Association of Independent Housing Professionals (NAIHP) sought a temporary restraining order blocking implementation, arguing that the rules were “arbitrary and capricious,” exceeded the Fed’s authority, and would do “irreparable harm” to consumers and loan originators. A District Court rejected the request but two judges on the U.S. Court of Appeals for the District of Columbia granted it on appeal.
That reprieve turned out to be temporary. The Fed requested a hearing by the full court, which went the other way and lifted the stay, ruling that the industry trade groups “have not satisfied the stringent standards required for a stay pending appeal.”
“Although the Appellate Court has ruled to lift the stay, this fight is far from over,” Mike D’Alonzo, president of NAMB, said in a press statement. “NAMB will exercise every option available to combat the consumer damaging Fed rule,” he added.
The Fed’s rules address allegations that, during the housing boom, some brokers intentionally steered borrowers to higher-rate loans on which their compensation was higher, even though the borrowers qualified for lower-cost alternatives. In addition to barring compensation to loan originators based on the interest rate or other loan terms, the rules prohibit loan originators from being compensated by both the borrower and the lender simultaneously.
NAMB and NAIHP argue in their suits challenging the rule that barring YSPs will devastate the mortgage banking industry and eliminate a funding mechanism that benefits many consumers. The restrictions aren’t necessary, the groups argue, because disclosure requirements provide ample protection to consumers who are offered YSPs.
“When balancing the equities and the public interest, the [Fed] entirely ignores the potential harm the rule could cause consumers by decimating the mortgage brokerage industry,” NAMB contended in its brief arguing for the stay. “The loss of these small mortgage brokers will leave a void in the mortgage industry and will directly result in less choice for the consumer.”
But consumer groups, who filed an amicus brief supporting the compensation restrictions, said they are necessary and long overdue. “If an existential threat exists to [the mortgage brokers’] profession, it is the macroeconomic environment, no this one small step toward reform,” the Center for Responsible Lending and the National Consumer Law Center argued. “The fact is, the credit and housing bubbles burst and…it was the absence of a rule like this that was in part to blame,” the consumer groups asserted in their brief.
REVERSAL ON REVERSE MORTGAGES
Facing a legal challenge by AARP, the Department of Housing and Urban Development (HUD) has had second thoughts about a policy change that required the surviving spouses of reverse mortgage borrowers to pay off the outstanding loan, even if it exceeded the value of the home, in order to continue living in the property. That change, announced in guidance published in 2008, reversed the agency’s long-standing policy extending to surviving spouses the guarantee offered reverse mortgage borrowers, that they could continue living in the home (as long as they maintained insurance and property tax payments) until they died or moved voluntarily. HUD’s new policy held that the guarantee did not apply if the spouses were not joint owners of the property.
AARP challenged the revised policy, arguing that it violated both HUD’s rules and contracts between reverse mortgage borrowers and lenders. HUD officials said they were rescinding the controversial guidance because “there has been some uncertainty” about it. They indicated that the agency intends to issue “new guidance” on this issue in the future.
AARP officials welcomed the reversal, but said it will not end their legal challenge. While HUD’s action “is definitely going in the right direction,” Jean Constantantine-Davis, a senior attorney with AARP Foundation Litigation, told Bloomberg News, AARP wants the agency to formally revise its regulations, not just issue new guidance, to ensure that the rights of surviving spouses are protected.
“We think the surviving spouses shouldn’t be displaced,” she said. “They have the right to stay there.”
PAYMENT PROBLEMS
The employment market may be looking a bit brighter if still less than luminous, but a large number of homeowners are still struggling to pay their mortgages. A recent Harris Poll found that 22 percent of owners with mortgages (about 32 million people) are having difficulty making their payments and 7 percent (11 million owners) report “a great deal of difficulty” hanging on to their homes.
Those statistics are marginally better than they were a year ago, when nearly 30 percent of owners said they were struggling and 11 percent reported severe problems. But the improvement may be misleading, according to Harris analysts, who pointed out that some of the owners reporting payment difficulties last year may have lost their homes.
Among the other survey findings:
- Two-thirds of adults – 66 percent – have mortgages today, down slightly from 69 percent in last year’s survey.
- More than 20 percent of owners with mortgages think their homes are worth less than the outstanding loan and 8 percent think they are worth “a lot less.” That’s a little better than last year, when 24 percent thought their homes were underwater and 11 percent thought they were considerably below sea level.
Harris analysts said the poll results are consistent with other data reflecting “a very modest, but still painfully slow, recovery from the recession.” Although the statistics reflect some gains, the analysts pointed out, “many millions of people are still hurting badly….It seems that we will continue to have a huge mortgage and foreclosure crisis until the economy is much stronger or house prices recover.”
Although more owners think they are under water on their mortgages, a separate survey finds that the majority of them frown on the idea of walking away from their loans. Contradicting reports that more owners are choosing “strategic defaults,” 60 percent of the owners responding to this survey by FindLaw.com said it was “never OK” for borrowers to default on loans they had the ability to repay. One-third (34 percent) said walking away was acceptable for borrowers unable to repay them, but only 3 percent agreed that owners should be able to default any time they chose.
