The six federal agencies tasked with coming up with a definition of a Qualified Residential Mortgage (QRM) have floated another proposal — one that would essentially do away with the QRM definition altogether.
To understand what that means, we need a bit of background, which economist Bill McBride was happy to give, and which I will happily translate.
When it was created, the Dodd-Frank Act had two goals (among others):
1. Protect consumers from predatory lenders
2. Protect investors (notably taxpayers) from unknowingly buying risky loans
Originally, Dodd-Frank was going to accomplish #2 by requiring that lenders keep some "skin in the game" — five percent of their loans would have to be on their own books.
But the mortgage industry pointed out that it would be a good thing if some loans were exempt from that five-percent-on-the-books requirement. Some loans were clearly solid enough that no skin in the game was required, it argued.
The legislators agreed, and thus Dodd-Frank sort of added a third goal:
3. Allow lenders to sell 100 percent of super-safe loans to investors (usually Fannie and Freddie)
That in mind, Dodd-Frank created two different loan standards.
To meet goals #1 and #2 (protect consumers and investors), there were qualified mortgages (QMs) defined by the Consumer Financial Protection Bureau. QM is based on borrowers’ ability to pay, and gives lenders a list of things they must do (e.g., keep fees low, verify borrower information, keep debt-to-income levels low, etc.).
To meet goal #3 (give lenders more flexibility), Dodd-Frank also created qualified residential mortgages or QRMs, which would be defined by six federal agencies. Instead of focusing on borrowers’ ability to pay, QRM loans had to meet other standards (such as a lower debt-to-income ratio) that "historical loan performance data indicate result in a lower risk of default."
Sounds similar, right? I mean, if a borrower has the ability to pay, the chance of default must be low, right? Well, not necessarily. QRM rules were supposed to go further to protect investors; the most famous suggestion floated was a 20 percent down payment requirement.
So: Basic QM requirements to make a loan, and stricter QRM requirements if you want to sell 100 percent of it to investors. (These days, the U.S. government is usually that investor.)
In January 2013, the CFPB did its part, releasing the QM rules.
But the QRM rules are still up in the air. The reason: concerns by lenders that the standards would be too strict and too expensive, and would keep many borrowers from getting QRM loans.
Of course, you say, that’s the idea — lenders should only be able to sell 100 percent of the safest loans. If it didn’t meet QRM requirements, lenders would only be able to sell 95 percent.
Here’s an analogy: The lender is baking a cake. If it uses the highest-quality ingredients, the government will eat it all (QRM). But if it substitutes some store-brand ingredients, the lender will have to take a bite, just to prove it’s safe (QM).
Well, lenders didn’t like that. They argued that keeping that five percent would be too onerous, so the only loans they’d make would be QRMs. (I.e., they don’t want to take a bite, so they’ll be forced to use more expensive ingredients.) Thus, a lot of borrowers would be out of luck because they couldn’t meet those stricter standards. (I.e., the high-quality cakes would be too expensive for many consumers.)
Well, those six federal agencies agreed that asking lenders to take a bite out of their lower-quality cakes was a bad idea. They announced that the latest QRM proposal would "define QRMs to have the same meaning as the term qualified mortgages as defined by the Consumer Financial Protection Bureau."
In other words, forget about the whole skin-in-the-game thing altogether — lenders wouldn’t need to keep anything on their own books as long as the loan meets those basic (QM) requirements.
So, to recap:
Government: The new rules will set standards for loans, and you’ll have to keep five percent of every loan on your books.
Lenders: Yikes! Couldn’t we create a super-safe category where we wouldn’t have to keep any ourselves?
Government: Sure thing. We’ll create a stricter category of loans, too. If a loan meets those requirements, you don’t have to keep any on your books.
Government: OK, here are the general requirements, and here are the stricter ones where you don’t have to have skin in the game.
Lenders: Yikes! The regular rules are all right, but the stricter rules are too strict!
Government: Well, if you want me to buy 100 percent of a loan from you, they need to be stricter. You can still make regular loans — just keep five percent.
Lenders: The only loans we want to make are the kind we can sell off completely. And these rules will make that hard.
Government: That’s the point… oh, all right. Forget those stricter requirements. You don’t need to keep anything on your books. We’ll buy 100 percent of every loan that meets the basic standards.
And that’s where we are today. The comment period for the latest proposal runs until October 30, 2013, after which we’ll get yet another proposed rule for QRM. And we’ll see what that brings.