Banned Mortgages You’ll Never See Again

A new government report tells us that American home values fell $9.1 trillion dollars as a result of the mortgage meltdown. You can bet no one wants to see that again, but just to make sure new rules under Wall Street Reform effectively end risky mortgages that certain lenders have come to know and love.

Laurie Goodman with the Amherst Securities Group and arguably the nation’s top mortgage securities analyst, says it’s ta ta and goodbye to several meltdown favorites, loans which will never become “qualified mortgages” or QMs.

Typical qualified mortgages include FHA loans, VA mortgages, portfolio loans and conventional financing. All are examples of qualified mortgages if originated with points and fees equal to less than 3 percent of the mortgage amount as well as fully-documented loan applications.

All are also examples of loans with little risk for either borrowers or lenders, no prepayment penalties and no “gotcha” clauses.

But according to Goodman some residential loans will never become QM financing. Here are five samples from her list, with my comments.

Interest-Only Loans — With interest-only financing the monthly payment equals the cost of interest so the size of the loan remains constant. There is no amortization with such financing, a bad idea for those who seek to lower their mortgage debt over time — and a source of great risk to lenders.

Balloon Notes — These are loans with reasonable monthly payments, say the same payment schedule you might have with a 30-year fixed rate mortgage, but they have a short term, say five years. ¬†Example, you borrow $100,000 at 3.5 percent interest. The monthly cost for principal and interest over 30 years is $449.04. However, the loan ends after five years and you suddenly owe $89,697.42. That’s the balloon payment. (Note that there are exceptions to this rule for small loans in rural areas.)

40-Year Mortgages — Instead of a 30-year term these loan last for 40 years. The advantage is a somewhat lower monthly cost with compared with a 30-year loan. For instance, our $100,000 at 3.5% has a monthly cost for principal and interest of $449.04. Stretch the loan term to 40 years and the monthly P&I cost of the loan drops to $387.39. However, because the loan has ten additional years the potential interest cost increases from $61,654.40 to $85,947.20. More importantly, because of slow amortization if the home is sold or refinanced after, say, eight years much more debt remains.

No Doc Loans — One hallmark of the mortgage meltdown is that borrowers could get loans with little or no documentation, essentially they could guess their income. No more. To have a qualified mortgage the borrower must provide complete documentation, with the term “complete” being determined by a lender who fears liability and lawsuits.

Loans With Big Fees — One of the hallmarks of the mortgage meltdown was “equity stripping” or “fee packing,” terms which meant that a borrower was instantly screwed from the moment of origination because the lender required 10 or 12 percent of the loan amount as a fee. Under QM rules, the maximum value of all points and fees cannot exceed 3 percent of the loan amount if the debt is $100,000 or more.

Can lenders still make the banned mortgage above? Sure — if they are willing to require 20 percent, hold a 5 percent reserve for the life of the mortgage and expose themselves to an endless number of potential borrower claims.

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