There is no doubt that one of the main reasons for the housing collapse was that mortgage underwriting became too lenient. It seemed anyone who wanted to purchase a home found someone to give them a mortgage; whether they actually qualified for it or not. These buyers eventually couldn’t make their monthly mortgage payment and many went into foreclosure.
This started the downward spiral in home values which crashed our economy.The government is now calling for adjustments to the definition of a “Qualified Residential Mortgage” (QRM) in order to guarantee this never happens again. Like many adjustments that follow a disaster, some are claiming the pendulum is swinging back much too hard. Let’s look at the requirements being considered.
The FHFA issued a Mortgage Market Note 11-02 last week which discusses QRM. Here are the highlights:
Types of mortgages that will qualify
A Product-Type qualified residential mortgage is a first-lien mortgage that is for an owner-occupant with fully documented income, fully amortizing with a maturity that does not exceed 30 years and, in the case of adjustable rate mortgages (ARMs), has an interest rate reset limit of 2 percent annually and a limit of 6 percent over the life of the loan.
Therefore, the following loans WILL NOT qualify:
- Alt-A (most of which are low or no document) mortgages
- Interest-only mortgages
- Negatively amortizing mortgages such as payment option-ARMs
- Balloon mortgages
Acceptable debt ratios
A PTI/DTI qualified residential mortgage has a borrower’s ratio of monthly housing debt to monthly gross income that does not exceed 28 percent and a borrower’s total monthly debt to monthly gross income that does not exceed 36 percent.
Payment-to-income ratio, otherwise known as front-end DTI, is the sum of the borrowers' monthly payment for principal, interest, taxes, and insurance divided by the total gross monthly income of all borrowers as determined at the time of origination. Debt-to-Income ratio, or back-end DTI, is similar to payment-to-income but adds all other fixed debts into the numerator of the ratio.
Down payment requirement
An LTV ratio qualified residential mortgage must meet a minimum LTV ratio that varies according to the purpose for which the mortgage was originated.
For home purchase mortgages, the LTV ratio will be 80% which means a buyer would need a 20% down payment.
Necessary FICO score
A FICO qualified residential mortgage has a borrower’s FICO score greater than or equal to 690 at the origination of the loan. The HLP dataset does not record delinquency history, prior bankruptcy of foreclosure, etc. of borrowers in the loans analyzed. For this reason, using a threshold of 690 for the FICO of the borrower at origination is a proxy for the absent detailed credit bureau data.
How many existing loans would pass QRM?
According to the FHFA report, less than half the loans originated over the last 12 years would have qualified. Here are the percentages that would have qualified based on the year the loan was originated:
- 1997 – 20.4%
- 1998 – 23.3%
- 1999 – 19.5%
- 2000 – 16.4%
- 2001 – 19.4%
- 2002 – 22.4%
- 2003 – 24.6%
- 2004 – 17%
- 2005 – 14.4%
- 2006 – 11.5%
- 2007 – 10.7%
- 2008 – 17.4%
- 2009 – 30.5%
We understand that the loans written during the years building up to the bubble were not scrutinized appropriately. However, it seems strange that only 20.4% of the loans issued in 1997 would meet the new criteria.
When will this take place?
We want to make two things very clear right now:
- These are proposed adjustments which are currently up for debate.
- Whatever is approved will only apply to government backed mortgages. The private sector will still be allowed to lend their money based on their own criteria (ex. 10% down payments).
However, there will be increased costs to lending institutions which do not use the QRM. Those costs will be transferred on to the purchaser.
What might these increased costs amount to?
Cameron Findlay, chief economist for LendingTree, in an article on the ramifications of QRM explained:
Homeowners who do not qualify for a loan that meets the new definition (mortgage insurance doesn’t appear to be part of the equation) would be forced to pay substantially higher rates. Early market estimates place that number as much as 3.00% higher than the QRM equivalent rate (on a $200,000 loan, that’s almost $400 more a month).
Others like housing economist Tom Lawler do not see the impact being as severe.
Loan qualifications will continue to get tougher and the costs of a mortgage will increase. Perhaps now is the time to buy that house of your dreams.