Jul 12, 2012
QM and QRM loans explained
12 Jul 2012
Posted by Andrew Kantor
One of the provisions of the Dodd-Frank Act creates two categories of mortgage loans that you have heard — and will hear — a lot about: QM and QRM.
As a Realtor, you’ll need to know about them because your clients are going to ask, and because starting sometime next year most of your clients’ loans will fall into one of those two categories.
The idea of both QM and QRM is to set a nationwide standard for mortgage loans that makes sure qualified people can get mortgages, but that lenders don’t offer (and borrowers don’t borrow) more than they can realistically pay back. It stems from the fact that, without such standards, lenders were offering loans to people without taking reasonable care to be sure they could afford them.
The standards have to be tight enough to protect consumers and taxpayers, but loose or flexible enough to ensure that just about everyone who should qualify for a loan does qualify. (The fear in both the real estate and mortgage lending industries is that these restrictions will be too tight, and qualified consumers would have trouble getting a loan.)
In other words, QM and QRM are going to have a profound effect on Realtors.
So here’s what you need to know about QM and QRM loans.
(Obviously this is a broad-brush treatment. There are lots of details about the requirements of each — e.g., limits on points and fees, balloon payments, and so on — that are simply beyond the scope of this piece.)
Keep in mind that lenders are certainly free to offer loans that do not meet these standards, but those loans (and any securities they’re packaged into) will not be backed by the government, nor will the lenders be safe from borrower suits if the default.
The standards for a qualified mortgage — QM — are being set by the Consumer Financial Protection Bureau (with input from other agencies and industry groups).
The idea of a QM is centered around “ability to pay” — what standards a borrower must meet in order to qualify for a QM loan. Those standards include all the things you would expect: current and expected income, debt-to-income ratio, employment status, credit history, other equity, and so on.
A QM loan will also require the lender to retain at least a five percent interest in the loan — so called “skin in the game.”
What are the issues with QM?
The main issue mortgage lenders have with QM is how protected they are from borrower lawsuits if they follow the rules. There are two possibilities for the final rule.
A) “Safe harbor” — borrowers who meet the QM standards will not be able to sue lenders if it turns out they didn’t actually have the ability to pay. Following the rule essentially grants lenders 100% protection.
B) “Rebuttable presumption of compliance” — If a lender follows the QM guidelines and a borrower sues, the lender has the benefit of the doubt (“presumption of compliance”) but the borrower still has the ability to sue (that’s the “rebuttable” part) in the case of unforeseen circumstances. It leaves the door open a crack.
The government should make the standards high enough and clear enough.
Mortgage lenders are concerned about option B), because they feel that defending against lawsuits — even if they prevail — will be prohibitively expensive (especially for smaller lenders). The government should make the standards high enough and clear enough that meeting them provides “safe harbor.” Further, without 100% protection they say, many lenders will shy away from making loans to anyone without top-tier credit.
Consumer groups, however, argue that it’s not right to close the door completely on borrowers, because loopholes and unforeseen circumstances might arise.
As Eric Stein, senior vice president for the Center for Responsible Lending told a House subcommittee, rebuttable presumption “gives lenders a considerable litigation advantage but allows a borrower to bring a case when there is a rare, starkly unaffordable QM loan and strong evidence available at the outset… a safe harbor standard would prevent borrowers from bringing any claim concerning an unaffordable QM loan even in situations where the lender has acted in bad faith.”
A second issue is exactly what the QM standard will be. For example, the CFPB is considering additional requirements if a borrower’s debt-to-income (DTI) ratio is above 43 percent. (About a quarter of Fannie/Freddie loans fit that description.)
But the National Association of Mortgage Brokers doesn’t like the idea of too many specific standards. Chairman John Hudson told a House subcommittee that “the entire mortgage industry is already adhering to the general ability to repay standards,” and “It will be unfortunate to both consumers and industry alike should the CFPB create a one-size-fits-all underwriting standard with relation to DTI ratios, assets, employment, etc.”
On the other hand, having vague or incomplete standards would not only defeat the point of the law, it would likely mean no “safe harbor” for mortgage lenders. (It’s hard to say you’re adhering to standards if those standards aren’t crystal clear.)
The bottom line is striking a balance between standards that are tight enough to protect lenders and consumers, but loose enough not to shut out too many qualified people.
A Qualified Residential Mortgage — QRM — is a loan that meets stricter standards than QM loans. Most importantly for lenders, they don’t need to maintain a five percent stake in any loan that qualifies as a QRM.
The QRM standards are being set by a list of Federal agencies, including the FDIC, Federal Reserve Board, FHFA, HUD, OCC, and SEC. Those standards are still up in the air, and probably won’t be finalized until 2013. One requirement that had been considered at one point was a 20 percent down payment, but that was taken off the table because of industry pressure that it was too strict.
What are the issues with QRM?
Simply put, what exactly the standards will be. Lenders will want most of their loans to be qualified as QRM, because they don’t want to have to hold that five percent stake. So they’re concerned that the requirements (which will by definition be stricter than for QM loans) will be too strict. Then they’ll have to choose between keeping skin in the game, or losing a large portion of their market.
But loose lending standards were a major cause of the housing bubble and the Great Recession. It’s clear that, left to their own devices, lenders will take extreme risks with lending knowing that taxpayers will (and did) bail them out. To protect taxpayers from another multi-billion-dollar bailout, QRM standards must be reasonably high… the key word being “reasonably.”
Various government agencies are still discussing and debating the details of the QM and QRM standards, so you’ll be hearing a lot more about them, pro and con. The QM standards will probably take effect around the end of the year, with QRM following soon after, but even that isn’t certain. We’ll keep you updated.
QM and QRM are meant to set reasonable nationwide loan standards that protect consumers and taxpayers.
QM: Set by CFPB, sets basic loan standards, requires 5% skin in the game. Main issue is whether lenders are completely protected if they comply or only mostly protected.
QRM: Set by SEC, FDIC, FHFA, HUD, OCC, and FRB, stricter than QM, removes 5% requirement. Main issue is how strict these standards will be, and whether too few borrowers will be able to meet them. (Lenders don’t want to have to hold 5%.)