Religion and politics used to be the top must avoid volatile conversation topics, until the birth of the Qualified Mortgage and the Qualified Residential Mortgage debates muscled their way onto the Billboard Top 10. Mortgage and real estate industry participants have been fixated on the January 10th, 2014 arrival of the CFPB’s new all-powerful consumer protection safeguards, the Qualified Mortgage and the Qualified Residential Mortgage. There are mortgage people that will tell you that Armageddon is upon us.
For the record, I am a “mortgage industry participant,” a retail mortgage loan originator, and I am not a fan of the Consumer Finance Protection Bureau, but contrary to many of my peers, I rate QM and QRM no more than a shrug and a yawn, except for one thing.
The spirit of these guidelines is to define a residential mortgage lending platform that is reasonable and prudent for consumers and lenders, that will keep the world safe from the wild-west lending frenzy that led to the financial collapse of 2007-2008. Mortgage people will tell you that QM and QRM guidelines were written by intellectual academics with no real world mortgage financing experience, thus the “overly” restrictive nature of the limits. CFPB advocates will tell you that mortgage people need clearly defined boundaries with clearly defined consequences attached; otherwise another catastrophic mortgage meltdown is inevitable.
So after hundreds of pages of proposed rules, comments, debate, amendments to proposals, industry lobbying, endless volleying, requisite fear mongering and judgmental assumptions, guess what? We have an industry standard that already exists. The CFPB is in fact late to the game with QM and QRM. Remember those titanic financial consequences that came from the way things used to be? It is the natural order of things in a market economy, that Adam-Smith-invisible-hand corrective forces emerge, and have in fact already changed the way mortgage lending is done. The mortgage approval process is an exercise in information vetting rivaled only by top secret government security clearance background checks. Credit, employment, income and assets are double and tripled checked to within an inch of an applicant’s financial life. If a guideline exception is needed for approval, justification and compensating factors are dissected for proof far beyond a reasonable doubt.
Mortgage lenders have no appetite for loans that may go bad, the consequences are too far reaching, and the sins of the past are still warm and steamy.
Enter the great debt ratio argument. The CFPB through the new QM and QRM underwriting guidelines, have decided that the absolute maximum debt ratio for any borrower should not exceed 43%. That means that the proposed mortgage payment, including real estate taxes, homeowner’s insurance, mortgage insurance and if applicable, common area fees (Homeowner’s Association Fees, Maintenance Fees, Co-op fees, etc.), along with all other recurring monthly consumer debt (auto loans/leases, student loans, alimony/support payments, personal loans, credit card payments, etc.), cannot exceed 43% of a borrower’s gross monthly income.
This absolute is proposed as the be all/end all cure supported by statistical analysis and default probabilities, and properly administered will bring order to chaos in the mortgage lending world. If we as lenders use the 43% debt ratio cutoff, we will substantially reduce the risk of loan defaults, buybacks, foreclosures and all of the ills that have brought about much needed reform in the mortgage lending industry. So says the CFPB.
This would seem reasonable and prudent, after all, why in the world would a lender allow a borrower to be so burdened with debt service that almost half of their income evaporates before they even get paid? But financial profiles are fluid, debts get paid off, incomes change, households change, often times one month is financially substantially different than another; individual cash flow management practices are as varied as DNA fingerprints. Attaching the 43% debt ratio ceiling to every mortgage lending request is akin to putting a 55 mile per hour speed limiting device on every car on the road, it may save some lives, but it is a narrow solution to a broader issue.
The broader mortgage industry issues are responsible lending, successful homeowners, lower default and foreclosure rates and stable homeownership trends. Imposing a hard 43% debt ratio cap is not the transformative magic wand that will accomplish these goals. The eight underwriting factors proposed under the Ability-to Repay Determination rule are substantially in practice already in our industry. It’s as if CFPB Director Cordray spent a day in a mortgage lender’s processing shop in an episode of Undercover Boss, and then published his findings as the Ability-to-Repay guidelines. Mortgage lenders are right now carefully considering (1) current or reasonably expected income and assets, (2)current employment, (3) monthly payments on covered transaction, (4) monthly payments on simultaneous loans, (5) monthly payments for mortgage related obligations, (6)current debt obligations, alimony and child support, (7) monthly debt-to-income ratios or residual income and (8) credit history. Fact is, mortgage lending scrutiny far exceeds what the CFPB proposes as necessary for a Qualified Mortgage or Qualified Residential Mortgage.
Dodd-Frank provides a Presumption for Qualified Mortgages that says the lender is presumed to have made the loan within the spirit of the Ability-to-Repay rule, but stops short of providing a safe harbor and allows for a full complement of ifs, ands and buts. Bad loan buybacks remain a threat. Mortgage lenders today prefer absolutes over presumptions, they absolutely do not want to buy back any more bad loans, and current underwriting practices are already in place to substantially prevent that.
In all fairness, the Ability-to-Repay rule does have a case-by-case provision for loans that exceed the mighty 43% debt ratio cap. The rule has even established a “separate, temporary category of qualified mortgages that have more flexible underwriting guidelines” as long as the rest of the loan and the overall spirit of the lending decision is consistent with QM and QRM guidelines. Great, we get to keep doing what we are already doing, prudent, responsible lending with an underwriting culture that asks whether we would lend our own money to a prospective borrower, how’s that for a test?
The CFPB forgets that mortgage lenders were not made whole from the titanic losses suffered from aggressive and reckless business practices of the previous decade. Painful, unrecoverable financial lessons, severe enough to transform the entire mortgage lending industry, have already accomplished what the CFPB thinks it is only now accomplishing.
There is one nagging little issue that the CFPB framers of QM AND QRM seem to be dismissing as less than material. Estimates ranges from 18% to 22% of all mortgage approvals have debt ratios above 43%. With the housing markets struggling for sure footing in a somewhat less than robust recovery, the CFPB is engineering a 20% +/- reduction in the strength of an economic engine that otherwise deployed, will lead to real, measureable growth in our economy and our recovery.
I need that thought process explained to me, after all, they must know what they are doing.
Right?
