Last Friday, the Consumer Financial Protection Bureau rolled out a series of new mortgage lending rules aimed at averting a replay of the 2008 financial crisis. The new regulations target some of the more egregious practices that helped entice home buyers into loans that proved to be unsustainable. Ironically, most of the mandated changes have already been adopted by lenders, so the net effect is likely to be negligible.
In essence, the CFPB guidelines represent a framework for qualifying the borrower. Lenders are required to make a reasonable, good-faith effort to demonstrate that consumers can repay their loans given their current assets, liabilities and documented income. This seems almost comically obvious, but the securitization boom of the early 2000s, abetted by the relentless policy pressure to increase home ownership, produced a surreal disregard of risk that led to dangerously relaxed underwriting standards.
The new regulatory regime creates a safe harbor that shields lenders from future lawsuits provided that certain requirements are met. Mortgages that meet these minimum requirements are deemed to be “qualified” and therefore presumed to satisfy the criteria for ability to repay. Qualified mortgages may no longer contain any of the more problematic features like negative amortization and interest-only payments that ensnared many previous borrowers. Additional fees and points are limited to a maximum of 3 percent of the loan amount.
In order to satisfy the affordability requirement, a QM must insure that a borrower’s total monthly debt service payments (including credit cards, car payments and student loans) do not exceed 43 percent of monthly gross income. Lenders are free to make non-qualified mortgages subject to their own standards, but do not benefit from the liability shield.
The new CFPB rules include several additional provisions intended to address past excesses on the part of lenders and servicers. In most cases, banks may not initiate foreclosure proceedings until a loan is more than 120 days past due, and may not begin foreclosure if the homeowner has proffered a completed application for help in restructuring the loan.
Of course, not all the blame for the mortgage crisis can be laid at the doorstep of lenders. Far too many borrowers disregarded time-worn guidelines regarding excessive leverage, assuming that appreciation or refinancing would eventually mitigate their burden. In this regard, the new CFPB guidelines fall short, as there is no defined minimum down payment stipulation for qualified mortgage loans. This is notable, since the requirement of a material down payment significantly reduces default risk.
Despite all the attention, the new regulations are unlikely to have much immediate impact on lending, other than to add additional cost and paperwork. It is estimated that 90 to 95 percent of newly approved mortgages already comply with the QM guidelines, thanks to tightened standards adopted by lenders since the crisis.
The biggest problem in mortgage lending remains the domination of the market by the humongous wards of the taxpayers, Fannie Mae and Freddie Mac. Thanks to their subsidized status, these behemoths now function as cash cows for the federal treasury, making essential reform even more difficult. Replacing government financing with private capital and the market discipline it brings is still the best way to protect consumers and taxpayers and to promote a stable and sustainable housing market.
Christopher A. Hopkins, CFA, is a vice president of Barnett & Co. Advisors.