About Those New Qualified Mortgage (QM) Rules...

About 20 years ago, it was fairly common for home builders to have close relationships with outside mortgage lenders.  This was done for two reasons:  to streamline the financing process for their buyers, and to bolster their competitive position by offering various incentives for using these affiliated lenders.  Throughout the 1990s, most large builders figured out that bringing these operations under the corporate umbrella – including in-house title and escrow services -- could make the process even more efficient, while also adding more revenue streams to the bottom line.

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However, with the latest rules released by the Consumer Financial Protection Bureau (created in July 2011 as part of the Dodd-Frank Act), the existence of these in-house affiliates are now in jeopardy.  In the original Dodd-Frank Act, the total sum of fees and points that lenders could charge consumers was capped at 3% of the loan amount (probably in response to mortgage brokers who routinely tack on points to borrowers whom are more difficult to qualify).  What the latest rules make clear is that this 3% will also include services such as title insurance, settlement costs, inspections, and escrow services when the provider is owned by the lender or part of the same corporate umbrella.  These new rules are expected to take effect in early 2014.

Not surprisingly, builders consider these new rules unfair, as dealing with external lenders have historically meant a higher risk that the deal won’t get funded in time for the original closing date, thereby creating frustration for both buyer and seller. For a builder like D.R. Horton -- which reportedly financed nearly 60% of its sales during the fourth quarter of 2012 through its own DHI Mortgage -- the ripple effect of this change, at least in the short term, could mean fewer closings and longer escrows.  This rule change is also one reason why NAHB’s widely watched Housing Market Index, which measures builder confidence, remained stuck at 47 in January following eight months of consecutive increases.

But those weren’t the only new rules released.  Although new Qualified Mortgage (or QM) regulations do create ‘safe harbors’ for lenders who follow strict underwriting requirements and quality controls, it could crimp lending due to financial risks for erroneously approving a loan outside of the new parameters.  For its part, the National Association of Realtors® is taking credit for a ‘significant victory’ in that safe harbor protection extends to loans underwritten to the automated standards of FannieMae, FreddieMac, FHA and VA.  Basically, safe harbor protects lenders from borrower lawsuits as well as having to buy bad loans back from investors.

The new underwriting guidelines are fairly common sense and straightforward, requiring creditors to verify eight factors:  (1) current or reasonably expected income or assets; (2) current employment status; (3) the monthly payment on the covered transaction; (4) the monthly payment on any simultaneous loan; (5) the monthly payment for mortgage-related obligations; (6) current debt obligations, alimony, and child support; (7) the monthly debt-to-income ratio or residual income; and (8) credit history.

Creditors must generally use reasonably reliable third-party records to verify the information they use to evaluate these factors, and loans with negative amortization, interest-only payments, balloon payments, or terms exceeding 30 years are prohibited from being qualified mortgages.  Also prohibited are debt-to-income ratios exceeding 43 percent of an applicant’s gross income.  While lenders could still underwrite some loans manually for otherwise creditworthy borrowers with defects which make them ineligible for the automated system, this “Presumption of Compliance” would require borrowers adhere to a larger set of standards.  In addition, since FHA and VA will require the automated underwriting system, in these cases manual underwriting may not get them approved.

The biggest complaint in high-cost areas such as California and New York is that the market for jumbo loans could be compromised due to the 43 percent debt cap as well as the prohibition on interest-only loans.  Since the market to securitize jumbo loans is limited and lacks the support of the GSEs such as Fannie and Freddie, look for higher down payments and more scrutiny from lenders willing to offer them.  To protect their constituencies, California Senators Dianne Feinstein and Barbara Boxer have asked CFPD Director Richard Cordray to review this situation so buyers of high-cost homes aren’t unduly punished.

And what is to become of sub-prime loans?  They’ll be a relic of history, with the only other option for such borrowers being the automated underwriting system of FHA, which is also tightening up its own credit standards and raising its fees.