Will “safe” QRM mortgages raise loan rates?

In an important step forward, the Consumer Financial Protection Bureau finally has a website — and a big issue to confront.

The question is fairly straight-forward: What’s a safe mortgage? There must soon be an official definition to comply with Wall Street reform measures passed last summer.

The Wall Street Reform Act tells us that government regulators must define something called a qualified residential mortgage or QRM. Lenders who sell QRMs are largely immune from borrower lawsuits and, no less important, they can readily sell those loans in the secondary market to mortgage investors.

So what’s a QRM?

  • In basic terms it pretty much looks like the definition will include conventional, FHA and VA mortgages with three or fewer points or other charges.
  • Such loans will be originated with fully-documented loan applications which include income and employment verifications.
  • In theory prepayment penalties will be allowed for QRMs — in practice FHA and VA loans do not permit prepayment penalties while prepayment penalties are rare for conventional loans.
  • Loans which are not QRMs will expose lenders to substantial liability and also require that they retain in reserve an amount equal to not less than 5 percent of the loan amount.

We know what FHA and VA loans are because program guidelines define such mortgages in endless detail. But what about a conventional loan?

We typically define a conventional mortgage as financing with 20 percent down made to borrowers with a given credit profile. Borrowers who do not have 20 percent down can still get a mortgage but they must purchase private mortgage insurance (MI).

But is 20 percent really the right number?

For instance, if we said that a conventional loan requires just 10 percent down then both borrowers and lenders would be thrilled — borrowers because they could buy real estate with less down and not need MI, lenders because there would be more loans to sell to investors.

Or, we could say that a conventional loan that requires 30 percent down. This would create a super-safe mortgage but require far more borrowers to finance with MI because they won’t have enough cash to meet the new down payment requirement. In effect, with more needed up front both mortgage volume and real estate sales would decline while rates would increase.

The Wall Street Strategy

Don’t be surprised if some big lenders want to define a conventional mortgage as financing with 25 or 30 percent down. Why? Because stiffer loan terms could then be blamed on Wall Street reform, still another way to gather public support for repeal.

But wouldn’t higher down payments hurt mortgage activity? Yes — but big banks and brokerages are now so large that mortgages are just a small portion of their business activities. Losing a little on mortgage revenue would be a small and short-term price to pay in exchange for an end to Wall Street reform. And if community lenders and credit unions get hurt that just means increased market share for huge banks.

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