There is an old idiom that a pendulum always swings too far, one way or the other. This seems to be the case with regulations on finance and lending. The Consumer Finance Protection Bureau recently released regulations designed to protect consumers from so-called “predatory lending” practices that were prevalent in many markets during the ‘boom’ years. My fear is that some of these regulations may restrict lending too much, swinging the pendulum too far.
In the wake of the real estate recession, the federal government introduced a variety of measures designed to protect consumers and weed out unprofessional or predatory mortgage loan originators. One of these actions has been the creation of a new federal agency, the Consumer Financial Protection Bureau (CFPB).
The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank Act) established the CFPB, which was launched in July 2011.
Here’s the mission statement of the CFPB: “The central mission of the Consumer Financial Protection Bureau (CFPB) is to make markets for consumer financial products and services work for Americans – whether they are applying for a mortgage, choosing among credit cards, or using any number of other consumer financial products.”
The basic idea is to heighten government accountability by consolidating into one place a variety of responsibilities that had previously been scattered across various government entities. The CFPB is like a one-stop-shopping center for consumer financial affairs.
Let’s explore what this means to you. The CFPB’s activities cover three areas: to educate consumers; to enforce federal consumer finance laws; and to gather and analyze relevant information.
We want to look at the CFPB and the guidelines they have announced on mortgages. What affect they will have on the national market, history will be the judge. In this analyst’s view, it will probably make lending more difficult. In Austin and Texas, because of demand and lack of inventory, we probably won’t feel the effects as much for the next couple of years. These regulations don’t go in effect until January 2014.
What the CFPB Can and Cannot Do
At this time, the CFPB only has the authority to enforce existing regulations that were previously under the control of other agencies. With one or two exceptions discussed below, there are no new CFPB-created laws or regulations that mortgage industry professionals or consumers need to learn about. The CFPB can only streamline existing functions and act as a clearinghouse for consumer complaints.
New Mortgage Disclosure Form
One program that directly impacts lenders and consumers is “Know Before You Owe.” This is a participatory effort that consumers and mortgage loan officers (MLOs) access through the CFPB’s website at consumerfinance.gov. As required by federal law, consumers who apply for a mortgage loan receive two forms: a two-page Truth in Lending disclosure form and a three-page Good Faith Estimate. By informing consumers and allowing them to compare mortgage offers, the forms are supposed to help the consumer pick the mortgage product that is best for them. The two current forms have overlapping information and can be confusing to consumers. The industry has said that they needlessly drive up costs and the regulatory burden on lenders. The Dodd-Frank Wall Street Reform and Consumer Protection Act, which created the CFRB, mandated that the CFRB combine these two forms into one.
To this end, during the summer of 2011 the CFPB posted on its website two different mortgage loans using the same draft version of a new, simpler disclosure form. MLOs are invited to comment. MLOs can click on the “switch to the industry tool” icon to be taken to the page that features two prototype loan documents for a typical $121,000 loan. The samples (called “Jasmine” and “Nandina”) can be downloaded as .pdf files. The prototype forms are reviewable are designed to combine both the Good Faith Estimate and the initial Truth in Lending disclosure, as mandated by the Dodd-Frank Act.
The CFPB promises that they will post drafts throughout the process, and give MLOs a quick, simple way to offer opinions on what works and what doesn’t. In the end, the new unified disclosure form will have to work for the consumers and lenders who rely on it every day.
Consumer Mortgage Counseling
For consumers facing foreclosure, the CFPB offers a website portal that helps the consumer get connected to a HUD-approved housing counselor. At no cost to the borrower, the counselor can help them work with their mortgage company to try to avoid foreclosure. The housing counselor will help the borrower organize their finances, understand their mortgage options, and hopefully find a work-out solution that works for them.
HUD provides an online list of foreclosure prevention resources arranged by state. Military members or veterans can call or visit the Veteran Administration’s home loan website to get personalized assistance.
The CFPB encourages at-risk homeowners to call and report foreclosure prevention and loan modification scammers who promise “guaranteed” or “immediate” relief from foreclosure, and who might charge very high fees for little or no services.
The ability of lenders to ‘dual track,’ is also under greater scrutiny. ‘Dual tracking’ is when mortgage services move to foreclose on a borrower while simultaneously negotiating a loan modification under new rules issued by the U.S. Consumer Financial Protection Bureau.
Regulating Mortgage Loan Servicers
The CFPB can require that companies who collect mortgage payments do not charge illegal fees or enroll a homeowner in overpriced insurance plans, keep accurate records of what the borrower owes, and do not either deliberately or accidentally push a homeowner into foreclosure.
What does it take to qualify for a loan today?
If a borrower has at least a 620 credit score and qualifies based on their documented income, they can get an FHA loan at 3.25% interest for 30 years fixed from most lenders as of the writing of this newsletter. Most mortgage bankers and brokers say that the automated underwriting system has made it much easier to get mortgage loans approved compared to when loans had to be manually underwritten and the debt to income ratios had to be 28/36.
How has this changed from the pre-recession loans? Below is a chart from Fannie Mae showing the percentage of business below 620 credit and above 740 credit. As you can see the business has changed.
In full disclosure, these new laws, which go into effect in January 2014, make changes and actually provides some substance to the skeletal structure of the Dodd-Frank Act, which stated that a lender had to ensure the consumer could repay their mortgage loan. (In other words, if the borrower defaults on a loan, the lender could actually be held liable.)
The CFPB has now proposed that lenders, to protect themselves from possible litigation, must make only “qualified mortgages” — a type of mortgage that must meet the following conditions.
No upfront fees or points in excess of 3% of the loan
A ‘Qualified Mortgage’ limits points and fees including those used to compensate loan originators, such as loan officers and brokers as well as points paid by the seller for closings costs, mortgage costs, etc. The CFPB continues to work on improving this. These parameters were put in place to prevent lenders from tacking on excessive points and fees to the origination costs, which in turn caused the consumer to end up paying a lot more than planned.
The loan cannot exceed 30 years in term length. A qualified mortgage cannot have risky loan features
In the lead up to the crisis, too many consumers took on risky loans that they didn’t understand. They didn’t realize their debt or payments could increase, or that they weren’t building any equity in the home. This provision was put in to prevent that abuse.
One of the other discussions by the CFPB is requiring larger down payments on all ‘qualified mortgages’ to the tune of 20% to 25%. Several government agencies are reviewing data to determine what will be the minimum down payment required under the new Qualified Residential Mortgage (QRM) guidelines scheduled to be revealed in the next few months. In the original Mortgage Market Note issued by the FHFA, it was suggested that loan-to-value (the percentage of the overall purchase price which was being borrowed) was a major factor in determining if a loan would default.
Basically, the original note suggested that a 20% down payment should be the new guideline. We realize that there has been much debate on this issue since and that the minimum down payment required under the new QRM guidelines will probably be less than 20%. However, we can’t know for sure.
Bloomberg reported last week: “The six regulators drafting the separate QRM rule, including the Department of Housing and Urban Development, the Office of the Comptroller of the Currency and the Securities and Exchange Commission, must decide whether to include such a requirement — and whether to make it less than the 20 percent they originally proposed.”
Will it be more difficult to qualify for a mortgage after the new QRM rules are announced? Most of us got into our first homes and still can for minimal down of 3.5 to 5% down. I would say there is greater likelihood of less people qualifying.
Realize that we currently have abnormally low interest rates. For every 1% increase (or decrease) in rates, borrowers can spend 12% more (or less). As rates increase, the larger downpayment should have the same type of dampening effect.
Do not think that this down payment issue is not meeting resistance. House Deputy Whip Tom Price (R-GA) in a letter to the SEC and other members of the financial services committee pointed out that this requirement would knock out 20 to 25% of borrowers for qualifying for ‘QRMs’. He argued that the ‘QRM’ exclusion from risk retention was particularly important for the stability of the United States housing market. In the Deputy Whip’s view, it is hard to envision the recovery of the housing market with unnecessarily high down payments, moreover this was never the intent of Congress in his estimation.
No interest-only periods or interest-only loans
No more “No doc/low doc” loans
“No doc/low doc loans” are when a borrower does not have to prove their income. Lenders must look at a consumer’s financial information. A lender generally must document a borrower’s employment status, income and assets, current debt obligations, credit history, monthly payments on the mortgage, monthly payments on any other mortgages on the same property, and monthly payments for mortgage-related obligations. Lenders will be required to verify all of this with information from independent third-party sources. This in turn prevents lenders from offering offer no-doc and low-doc loans, where lenders made quick sales by not requiring documentation, then offloaded these risky mortgages by selling them to investors.
No negative amortization loans
In this lending scheme, the loan payment for any period is less than the interest charged over that period, so that the outstanding balance of the loan increases.
Restricts balloon principal payments and pre-payment penalties in most cases
Debt-to-income ratios for borrowers must be equal to or less than 43%
Under the Ability-to-Repay rule announced, all new mortgages must comply with basic requirements that protect consumers from taking on loans they don’t have the financial means to pay back.
A borrower has to have sufficient assets or income to pay back the loan
Lenders must evaluate and conclude that the borrower can repay the loan. For example, lenders may look at the consumer’s debt-to-income ratio – their total monthly debt divided by their total monthly gross income. Knowing how much money a consumer earns and is expected to earn, and knowing how much they already owe, helps a lender determine how much more debt a consumer can take on.
Teaser rates can no longer mask the true cost of a mortgage
Lenders can’t base their evaluation of a consumer’s ability to repay on teaser rates. Lenders will have to determine the consumer’s ability to repay both the principal and the interest over the long term – not just during an introductory period when the rate may be lower.
The loan must be a prime loan (the interest rate must be close to the national average prime mortgage rate)
The loan is eligible to be sold to Fannie Mae or Freddie Mac
The new CFPB law shouldn’t have a positive effect on the national real estate market because it continues to keep a lid on lending, and doesn’t allow the mortgage market to create what it considers to be a good loan. In other words, it puts restraints on the free market to be able to make its own choice about what should constitute a worthy borrower. It is difficult to find the middle ground between an excessively regulated environment (in which real estate markets lag because lenders are unable to approve enough borrowers), versus one with no regulations — a la 2006, when the markets gave free rein to giving mortgages to less than worthy borrowers. The CFPB’s ban on “teaser rates” (very low interest rates that increase to much higher rates after a short period of time, such as one year) might not affect the industry much in our present low-interest-rate environment, but could severely impact real estate sales if rates rise over the next few years. Thank goodness we live in Austin and Texas.
The only saving grace for the real estate industry is at least now there is some clarification of the changes that Dodd-Frank promised to bring — that is until some lawsuit brings about a whole new set of regulations designed to help the consumer (but which may have the opposite effect).
How will this play out is hard to say? On one hand, we all understand the needs to better protect the consumer. On the other, overprotection is counter protective. Only time and history will tell.