THE GOVERNMENT'S NEW QUALIFIED MORTGAGE
Post Date: 6/1/2013
JUNE, 2013 ANNOUNCEMENT:
THE GOVERNMENT'S NEW
STARTING LATER THIS YEAR, MONEY IS GOING TO BE EXPENSIVE AND HARD TO FIND IF YOUR BUYERS DON'T QUALIFY FOR THE NEW MORTGAGE (AND MOST WON'T) MANDATED BY THE U.S. GOVERNMENT!
(SO THEN WHAT HAPPENS TO
SALES AND MARKET VALUES?)
J. ROBERT ECKLEY
Real Estate and Banking Attorney
JUNE 1, 2013
© 2013, THE ONLINE LAWSTORE, LLC
INTRODUCTION: TODAY'S BACKDROP AND THE COMING NEW "QUALIFIED MORTGAGE" AND "SKIN-IN-THE-GAME" RULES
TODAY'S REAL ESTATE MARKET AND FINANCE: Recent "game-changing" trends in finance and mortgage underwriting brought on the effects of new standards under the now-implementing Dodd-Frank Act (the "DFA") and the Consumer Financial Protection Bureau (the "CFPB") (calling for more down for qualified income-to –debt ratios, higher FICOs, the inclusion of recurring debt into back-end income-to-debt ratios, in-depth income verifications, tighter appraisals, the coming interest increases, limited availability jumbos and especially the general unavailability of super jumbos) coupled especially with wind-downs of the short-sale markets in many locales have made selling middle and upper tier properties tough to impossible. Many potential residential sellers—disappointed by the law-ball appraisals that dominate a spooked mortgage industry and which continue to hold their values under their existing mortgages—have stayed off the market, entirely, making listings low and tight. A high pent-up marketplace that is too solvent and credit-conscious to short sale or walk on their properties awaits values to appreciate beyond their existing debt or the return of the higher mortgages classes that presently appear nowhere on the horizon.
In the commercial world, things are just as bad under the tightening of bank standards by the DFA. The state-charted savings banks and banks that are the traditional avenues for most local commercial finance are broke, under regulation or closed and the majors are standing way, way back, following the leads of Fortress Five in doing their own proprietarial deals and playing Wall Street ("to heck with lending!"), as a matter of portfolio management. There are almost no open market buyers for commercial CMBS and if the government was not supporting the CMBS' resale market by buying them at retail there would be none at all. The only real action has been the big buys and assemblages of the mega vulture REMICs and REITs and that has for the most part been both a market outside of what most serve or can reach and, in any event, a seller's nosebleed.
Couple this on both the residential and commercials side with erosion in the borrower market (fewer and able to afford less) and a general unwillingness of the better-informed buyer or investor to enter a marketplace where values still seem to the sliding unless the product is given away and the scene, thought seemingly better today than it was five years ago or even last year, still looks rugged, indeed on a broader perspective.
NUTSHELL FOCUS ON RESIDENTIAL FINANCE:
GENERALLY: Under the new mortgage underwriting criteria established for all lenders under the DFA as ruled upon by the CFPB, borrower loan qualifications have severely been tightened, loan maximums based on gross income-to-debt have been raised to approximately 2.33:1, appraisals and credit scoring have been tightened, and certain mortgages (the ones that fed much of the last boom, like "stated income", interest-onlys, balloon notes and teaser-rate variable rate loans) have been prohibited entirely or made unattractive to lenders by making them harder to bundle and more expensive to resell.
THE "NEW CONVENTIONAL" RESIDENTIAL LOAN: THE CFBP has ruled that the residential mortgage world shall henceforth have two distinct types of mortgage, one that is "freely marketable" by lenders and is the "gold standard" for future government-approved bank (the dubbed the "QM"as will be seem below) and mortgage portfolios and one that is, well, the "lead sled"---a sort of a rogue mortgage that the GSEs (Fannie, Freddy, Ginny, etc.) will not buy, the lenders will be deeply discouraged from generating at all (unless they want to hold the resulting debt themselves for the life of the debt) and it accordingly intended to suffer almost a "junk" underwriting rating intended to discourage resale (the "Non-QM," see below).
Whether a residential mortgage will be the exalted and stately QM or the "lowly scoundrel" Non-QM is all about the borrower's proven ability to perform historically and currently verified ability to easily repay and how far the mortgage strays from the old, traditional vanilla mortgage of your father's time: One that is appraisal-beaten-down, fully-amortizing, no balloons, with fixed, equal-payments. That's the QM. The rest are intentionally placed the government in the "hogs and dogs class" on this new financial voyage. They may have to be portfolioed to even make them and few lenders have cash reserves or a deep enough discount on wholesale credit lines to hold a hog-and-dog pen that large Frankly, the government is hoping that few lenders even have the temerity to want to issue these.
We all might agree that getting quality back into the market to avoid a repeat of the last collapse is a good idea. The problem is for those "waiting for the market to come back" that it was the Non-QMs that financed 80% of the sales of that last boom market. IF EVERY FINANCED DEAL HENCEFORTH NEEDS TO BE BY A "QM" IN ORDER TO FIND REASONABLY-PRICED (OR EVEN ANY) INSTITUTIONALIZED MORTGAGE MONEY, IS A "COMEBACK" EVEN POSSIBLE?
A CONVENIENT SHORT-HAND CHART TO DETERMINE THE "QM" FROM THE "NON-QM": It would take a two-day banking course to explain all of the rules that make a mortgage (and a borrower or deal) "QM"-eligible or "non-QM-eligible (read "alive" or "dead or flirting closely with death," respectively). For those who are in the residential market either as borrowers, investors or marketeers, this distinction is going to determine careers and make or break financial futures.
Instead of taking that course, however, here is a chart and some footnotes to it that condenses it into a more intelligible whole and more clear distinction.
"QM" ROULETTE: Here is the chart. Keep it someplace close from now on.
HERE IS HOW THE NEW MORTGAGE RULES WILL WORK IN A NUTSHELL
LOAN CEILINGS: Interpreting the chart, above, the Qualified Mortgage rule, or QMR, lays out basic requirements for lender underwriting. These are for GSE-limit loans, meaning loans not to exceed a U.S. maximum (currently) of $729,750, but as further lowered by a formula for each local jurisdiction—calculated as 125% of local median prices in each U.S. metro area. Jumbos (usually above the local ceiling where the local ceiling stops before $650,000) still qualify as a QM, but may not be purchased by the GSEs and would have to go to the private market. Super-jumbos (complexly outside of the GSE limits and jurisdiction, so usually defined by the internal policies of the issuing lender, now commonly starting at $1.1 million and above, but median averaging $5-$10 million) are proprietarial, many times portfolioed by the lender or investor and are usually are so customized to the borrower and collateral that they do not meet generic QM qualifications and are thus excluded entirely from current QM ratings. Even if they meet the other QM standards, there are limited placements for them and thus implicitly they appear for the time being to be "Non-QMs" in fact and practice if vague in regulation. Between the Non-QM status and the federal Home Owners' Equity Protection Act ("HOEPA") limitations, hard consumer-loan mortgage money is mostly gone.
BORROWER'S ABILITY-TO-REPAY: For those under the QM ceiling and in short, the originator of the loan must verify all sources of income and assets and verify that the borrower has the ability to repay the mortgage (ATR) and that with rate the consumer and the loan as "QM" ("the loan of the Gods") or a "Non-QM" (a loan having a close affinity with "Financial Satan"). A number of loan types are prohibited per se from receiving the QM status, including those with negative amortization, balloon payments, interest-only features, as well as those with durations greater than 30-years. Finally, there is a cap on fees that lenders can charge of 3% (with an exception for loans under $100,000) and the back-end debt to income ratio ("DTI"—the combination of the principal, interest, taxes and insurance on the proposed mortgage ("PITI") plus the borrower's recurrent debts, including installment debts, open credit (auto loans, student loans, etc.) must be less than or equal to 43%.
RATES LIMITS: Mortgages that qualify as a QM will be further bisected by those that have a rate 1.5% above the prime borrowing rate and those that do not. Loans below the 1.5% will receive special legal status known as a safe harbor, where the borrower in default must first prove that their loan was not affordable when originated in order to sue the lender. If the loan is QM and above the 1.5% rate threshold, then there is a rebuttable presumption where the lender must prove that the borrower had the ability to repay. Under the rebuttable presumption, even if the lender can prove the loan met the borrowers "ability-to-repay" standards ("ATR"), the lender incurs legal costs making the case of $70,000 to $110,000.
THE EFFECT: According to some industry analysts, while other analysts argue that the incidence of claims would be extremely low on these, if the lender cannot demonstrate that the borrower had the ability to repay, then the lender faces new enhanced legal fees. Furthermore, the borrower's ability to fight the foreclosure of this kind of a mortgage applies for the life of the loan, which would extend foreclosure timelines, increasing costs to banks. Lending outside of either definition of a QM may be sparse as the lender would have to raise rates further to compensate for litigation risk since these would fall outside either definition of a QM loan; these higher rates might then reach the limits set by the federal Home Owners' Equity Protection Act ("HOEPA"--HOEPA does not permit lenders to over-reach with oppressive mortgage terms and other restrictions—but that is a discussion for another day or article in the present context).
SO WHO WILL BE IN "NON-QM SIBERIA"?
- Jumbo loan users with DTIs greater than 43%, which is estimated to be roughly 0.5% to 1.0% of the entire market; super-jumbos are implicitly wounded (and will be hard to find) for all but those who really do not need to borrow the money or are granted them as "perks" to a wider and more lucrative banking relationship with the customer, or come from hard-money lenders who can find acceptable profit in skating narrowly under the rate caps and HOEPA rules and who must logically be asset-based lenders, as most high income or high net worth borrowers will not need to use hard money.
- Mortgages where fees are greater than the 3% cap – this is difficult to quantify, but it could be a large portion of the market. Still, lenders can "pay for" some costs by including them in a higher rate, so long as it is under the 1.5% cap, thereby ameliorating the impact to the market.
- Borrowers who use interest-only or negative amortization loans. Some estimates have this portion of the market in the range of 15%. However, this type of financing is commonly used by wealthier individuals with large reserves who can shift to different financing options.
- Borrowers with interest rates 1.5% or more above the average prime borrowing rate are roughly 4.9% of the purchase market and just 0.04% of the jumbo segment. Some borrowers in the conforming space may be able to shift to FHA, which is seeking an exemption to this point, but more borrowers may be pushed into this space if banks finance origination costs to comply with the 3% cap.
- The subprime market will be more restricted. The FHA will likely be the only option for borrowers with a FICO less than 620 and DTI over 43% as the FHA recently rescinded the ability to process these loans through automated underwriting. Most will need to start in the 700s and the jumbos and jumbo-plus in the 800s.
RAISED BARS ON DOWN PAYMENTS AND BORROWER QUALIFICATIONS AND DOCUMENTATION: The qualification hurdles for the borrowers have also been substantially raised by the Dodd-Frank Act (see Dodd-Frank Act title in detail, below). Documentation is now extensive for traditional third-party mortgages and there will be higher mandatory down payments and rougher appraisal standards. The down payment and appraisal requirements will not apply to owner-carries and the documentation requirements to qualify the buyer will be far more modest for seller-carries than conventionals. Again, see the fuller Dodd-Frank act.
USE OF AUTOMATED UNDERWRITING: Lenders can use the automated underwriting models of the GSEs and FHA to vet mortgages that are not financed by the government since there is currently no automated underwriting for a QM loan. Jumbo loans will have to be manually underwritten as there is no automated underwriting for jumbos. As a result, these may take more time or cost slightly more to compensate originators for the underwriting costs and risk of writing to the QM definition.
THESE CRITERION ARE NOT REALLY FINAL: In time, though, the FHA, USDA, and VA will derive their own QM definitions and the GSEs could come out of conservatorship. When this happens, loans not meeting the new QM definitions established by the government agencies will need to meet the narrower QM definition. By that time, it is hoped that lenders will have more confidence in making non-QM loans. In the near term, this final rule should help to stimulate some bank and investor demand for non-government backed QM mortgages as it clarifies and boosts protections for lenders and who make loans and hold them in portfolio or shelve them for securitization.
THE EARLY EFFECT OF THE QM RULES: An outcome of the new QM rule is that it will raise the importance of the high-cost loan limits that delineate the maximum limits at which the GSEs and FHA can lend. In high cost areas like California, New York City or Washington, DC, many borrowers may not be able to use the government programs or their automated underwriting programs. As a result down payment may rise as buyers with debt-to-income ratios ("DTIs") greater than 43% seek to reduce mortgages below conforming limits in order to avoid the more strict 43% limit on QM loans in the jumbo space. First-time buyers in these areas may be the biggest casualty, as this group may not have the resources to increase down payment. As a result, the loan limits will play an increasingly important role as home prices rise over the next decade. Worse yet, if loan limits were to decline, a larger portion of the market would fall outside the QM. In addition, for safety and expediency, lenders are likely to defer to the agency's automated underwriting ("AU") systems in the near term. This shift places more importance on how the AUs are defined by the agencies going forward.
A BIGGER FLY IN THE OINTMENT—THE NEW RISK RETENTION OR "SKIN-IN-THE-GAME" RULES:
Of considerable importance to those underwriters who originate mortgages that are below QRM standards or outside of the QM jurisdiction (super jumbos for example): the DFA mandates that originators and transferees must remain totally responsible for them and they must be reserved against by originators and by the entire subsequent chain of investors to be qualified for bundling as mortgage-backed securities ("MBS"). All parties in chain from origination to resale of the non-QRM mortgage now have "cradle-to-grave" full recourse liability for the MBS and must maintain a 5% cash reserve against the total of all mortgages the originator and subsequent holders ever handled, whether held, seasoned or resold until each is amortized and concluded. Many big institutional investors such as pensions and trusts are limited by their rules to investing only in SEC-governed MBS. It is now part of the transferors' industry reps and warranties. And the MBS is where almost all of the resale capital is. Couple that with the Rating agencies now having the wake-up calls after suffering through a number of investor suits for being "quality-deaf-and-blind" from the last collapse and you have a perfect storm blowing against all but the most guilt-edged mortgage product: The MBS made of questionable QM clay is going to get red-tagged; the Non-QRM offering will get the black ball. Skin-in-the-game or not, in another downturn, it is doubtful that any vendor could really take the hit of covering full recourse for a major part of its last several years of sold inventory. Realistically, a 5% indemnity per flip of the mortgage is about all any buyer or Rater could ever count on without upping his or her malpractice insurance.
Obviously this "skin-in-the-game" rule is meant to encourage lenders and investors to be more cautious in their loan underwriting standards than they were in yesteryear. With no more "caveat emptor" originations and assignments, it is reasoned that their underwriting sins will now come back to haunt them both financially and judicially and they will be thereby deterred. This, of course, assumes this cadre cares enough about it's own hide to take renewed care when the profits of volume are at stake. After assessing the lending industries' stunning chutzpah (if not cold-handed fraud) revealed during the last collapse and noting the most of the same "cast of characters" in that debacle are still inside the industry, that could still be a lofty assumption, indeed. When the cat is away, sooner or later, the mice will play. And at this point the DFA's and the CFPB's retort to that—whether one believes it possible or not--is that it intends to put cats with long, sharp claws behind every corner in the business. Whether there are enough CFPB or other regulatory auditors or reliable "automatic systemic burglar alarms" to deep-audit and signal corrupted underwriting amid millions of deal files, the efficacy of every transferor reserve, or the scruples of every man, woman and computer in the system awaits testing. Even if it works, one might also ask what the ultimate efficacy may be of a capitalist system—where risk is one, but the only god of profit--when that system is chilled by the cool gaze of Financial Cops with handcuffs peeking over every file cabinet and bugging every software system in conventional lending and investment. But that's another story.
CONCLUSION: THE IMPACT ON THE COMING MARKET
After nearly two years of waiting, the final mortgage underwriting rules have been released. While some aspects of the rules are expected by some market-watchers to limit market activity, the long awaited clarity is hoped by the Regulators to stimulate demand. That hope might be dangerously naive. The QM rules tighten credit considerably, as does the MBS "skin-in-the-game" reserve rules. Add to that tightening effect the Fed's hints that the ceiling will shortly be eased off interest rates (with higher interest rates meaning even less borrowing power under the above QM formulas and climbing rates also bumping inevitably into a market-tolerance barrier that will affect sales and prices) and things look a bit dicey for the coming marketplace, to say the least. Tightening credit right when some life is being seen in the real estate marketplace is certainly taking a large risk of dampening the flickers before they become a sustainable flame.
There is more to this worry and it has to do with credit pools and mortgage capitalization. Before traditional lenders and investors come back to the loan market in strength, the market will need to re-incentivize them (in some cases regulatorily, as for example where the DFA attempts to close off commercial banks from ignoring traditional borrowers and acting more like investment banks through the prop desk—in other ways, yes, regretfully, by the Fed allowing interest rates, yields on mortgage investments, to rise). In some cases, additional clarity is also needed and yet to come in Truth in Lending Act ("TILA") and Real Estate Settlement and Procedures Act ("RESPA") rules, which are the channels by which mortgage lending is delivered to the marketplace, and right now these are yet in regulatory flux. The DFA also needs to complete the implementation of the Banking rules which institute Basel III (raises required banking reserves, in some cases lowers net worth by the new treatment of loans and mortgage servicing rights on bank balance sheets) before the Banks are likely to want to do anything but stay conservative by remaining reserve and Wall Street heavy and mortgage-lending light. This makes even more sense when interest rates seem ready to climb. Why would any lender want to make a fixed rate loan at today's interest rate when tomorrow it could start to climb? And under the QM rules, the lender cannot even protect itself from the upward interest pressures by issuing a variable-rate loan, since the new QM rules (the borrower has to qualify on variable-rates at the highest rate the loan could climb over the first 5 years) allow few borrowers to qualify at all and few good borrowers wanting to sign anything that could so likely see today's artificially-controlled lowball interest go up?
All of these pending Regulatory "To-Dos" paralyze credit delivery systems, limit long-range bank and investment planning and pinch credit volumes, regardless of what a QM might be. In the end, the real effect of all of these magnificent safeguards could be to significantly reduce credit volume—certainly for non-QRMs which, as was noted, composed most of the financing which supported the last strong market. So now it is regulatorily-wired that the market cannot legally go back to the lending practices, standards and capitalization that predicated the prosperity of the last boom market. Accordingly, what the government-forced flight to only five-star mortgage lending might mean for those who are still coping with yesteryears' market by excruciatingly sustaining properties that are still yet underwater hoping to relief to come is that they are fools. The coming of either more liberal financing to re-amortize the pain has been dashed by the new mortgage risk-retention and mortgage-back securities ("MBS") rules and any price inflation at a rate that could re-inflate values past secured debt would be retarded by rising interest rates as they disqualify buyers and undermine prices as they go through the QM grinder.
POSTSCRIPT—COMING ATTRACTIONS!: See our next issue on combating the QM and price debilitation in the marketplace through the renewed use of Seller-Carried Finance: "It's Back and Beautiful."
THIS PRESENTATON IS NOT THE RENDERING OF DIRECT LEGAL, REAL ESTATE, ACCOUNTING OR LOAN ADVICE AND IS PROVIDED AS A COURTESY TO THE PUBLIC FOR GENERAL EDUCATIONAL PURPOSES ONLY. PROPER LEGAL, FINANCIAL AND ECONOMIC ANSWERS VARY GREATLY FROM CASE TO CASE AND THUS REQUIRE SEPARATE AND DIRECT ANALYSES IN EVERY EVENT. ALL LEGAL, ACCOUNTING AND GENERAL ADVICE SHOULD THEREFORE IN EVERY CASE BE SOUGHT DIRCTLY FROM A COMPETENT, LICENSED PROFESSIONAL.