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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.

Lenders: Great!

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.

QM and QRM loans explained

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.

QM

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.

QRM

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.


tl;dr

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%.)

No QRM rules in 2012

Housing Wire is reporting that Federal officials have confirmed that qualified residential mortgage standards and rules won’t be released/in place in 2012.

Reminder:

QM = qualified mortgages; all mortgages must meet these broad standards.

QRM = qualified residential mortgages; a stricter standard a loan must meet if the lender wants it to be backed by the Federal government

Both standards are up in the air. QRMs will likely have a down payment requirement (at one point 20% was being considered, but that’s pretty much off the table).

The Consumer Financial Protection Bureau, which is leading the effort to develop the standards, has already said that QM rules won’t be in place in 2012. And today other regulators said that QRM rules would be developed after QM.

Ergo, no QRM in 2012.

Read all about it.

QRM definition still up in the air

What will the standards be for a qualified residential mortgage — a QRM? Those are the loans that Fannie and Freddie will be willing to back, so they’ll essentially be the best (aka least expensive) around.

The original suggestion required that a QRM include a 20 percent down payment, or else the lender would have to hold onto five percent. Naturally, we didn’t go for that at all, nor did a long list of other organizations.

So “rulemakers” (that is, federal regulators and their kin) opened the definition for public comment: What should define a QRM? And comments they got, by the bucketful. And although the comment period ended August 1, those rulemakers are still going through them — i.e., they haven’t made a decision.

It’s an issue we’re watching closely, believe you me. As are, apparently, lawmakers on Capitol Hill.

Click here to read Housing Wire’s story all about it.

Or click here to see all we’ve written about QRMs.

QM vs. QRM — crucial differences

There are two types of mortgages covered in the Dodd-Frank Act, and both are going to impact Realtors in a big way. They meet very different requirements, and the American Securitization Forum wants to make sure that Federal regulators enforce that.

You’ve got QMs (qualified mortgages) and QRMs (qualified residential mortgages).

The standard for QMs is fairly broad: A lender must ensure that any borrower has the ability to repay the loan. (There are nine standards that determine this.)

Just about every loan is going to be a QM — there are legal penalties for banks that write loans that don’t meet the standards. And by meeting the standards, lenders are shielded from some liability. (Borrowers won’t be able to say “The bank should have known I couldn’t pay.”)

Only in limited circumstances are banks allowed to make non-QRM loans.

QRMs, on the other hand, are a subset those loans. They have to meet stricter standards — standards that still haven’t been determined, and could include the infamous 20%-down requirement.

Banks and other lenders are free to make non-QRM loans, but there are discouragements. For one, the lender could only sell 95% of the loan to the secondary mortgage market; it would have to keep 5% on its books as “skin in the game.”

More importantly, neither Fannie Mae nor Freddie Mac will buy any part of a non-QRM loan. Considering they own 90+ percent of the secondary mortgage market, that means it will be pretty hard for any lender to sell a loan that doesn’t meet QRM standards.

The bottom-line message to lenders from Dodd-Frank: “Your loans must meet some basic requirements, including the borrowers’ ability to repay (QMs). And if you want to sell those loans to Fannie or Freddie, they’ll have to meet even stricter requirements (QRMs).”

The law says every mortgage will meet QM standards. Common sense says that almost every mortgage will meet QRM standards as well (whatever they are). Still, they are two separate things, and that’s what the ASF wants to be clear.

A loan could meet QM requirements but not be a QRM, and the ASF wants to be sure that lenders who issue those still receive protection from liability. In other words, it doesn’t want the two definitions merged, even if the vast majority of loans will likely be QRMs.

It told Housing Wire that, when the Consumer Financial Protection Bureau issues its final rule about QMs, that rule “balances the important need to protect consumers with the legitimate goal of providing institutional investors in the capital markets.”

Click here to read the full Housing Wire story.

Most loans already meet QM standards; read about that here.

More lawmakers have signed a letter to Federal regulators requesting them to lower the 20% down payment on the qualified residential mortgage. This puts the number of lawmakers opposing the 20% rate at more than 320, according to NAR. Virginia lawmakers Bob Goodlatte and Rob Wittman join Gerry Connolly, Robert Hurt, James Moran, and Frank Wolf in standing up for reasonable home mortgage standards.

You can read more about QRMs here (Housing Wire) and here (VARealtor.com).

Anti-QRM forces gathering steam

OK, while — as Realtors (and their supporters), we vehemently oppose the proposed Qualifying Residential Mortgage rules. Asking for 20% down to get the best rates is foolish at best, and will probably grind the housing market to a halt.

We’ve been banging this drum for some time, and bit by bit it’s been gaining the public’s attention. In the last few days, in fact, it’s been picked up by both MSNBC (“Proposed rules could shut many out of housing market“) and the Washington Post/Bloomberg (“Federal housing proposal would toughen debt restrictions on mortgages“).

The six Federal agencies tasked with defining what makes a mortgage “qualifying” had set June 10 as the deadline for comments, but then extended that period till August 1. That — plus the increasing press coverage — could indicate the feds are rethinking what makes a QRM.

 

Here’s a beautiful example of why we’re fighting tooth and nail to ensure reasonable lending standards.

According to HousingWire, which used CoreLogic’s data, 39% of homebuyers in 2010 put down less than 20% on their purchase. Meanwhile, the current proposal defining a Qualified Residential Mortgage — one that banks could sell to Fannie or Freddie — would require, among other things, a 20% down payment. Without it, the bank would have to hold onto the loan, making QRM essentially the minimum standard for borrowers.

So CoreLogic crunched the numbers, and found that, were QRM in place in 2010, 39% of buyers wouldn’t qualify. So you can bet that a vast majority of them wouldn’t have gotten a loan.

Can you imagine if 2010′s sales were 39% lower than they were?

Down payment is not an indicator of loan performance. The difference in foreclosures between people who put down 20% and those who put down 5%? About half a percent. In other words, nil. Smart underwriting makes solid loans, not down payment requirements.

Making the folks on Capitol Hill understand that is just one of the battles we’re fighting these days. (You can read a lot more in the upcoming issue of Commonwealth.)

30 seconds on QRM: What you need to know

If you don’t know about QRMs — or don’t know enough — you need to. They’re going to be a central part of the mortgage market.

QRM: Qualifying residential mortgage. In other words, a mortgage that meets certain requirements. If it meets them, the U.S. government (through Fannie Mae and Freddie Mac) will be happy to buy that mortgage from the originator. If a mortgage is not a QRM (that is, if it doesn’t meet those requirements), then the originator will be required to hold onto 5% of the loan. That way, they won’t be able to pawn off risky loans onto taxpayers.

But what are the requirements to qualify? Answer: That hasn’t been decided yet. Regulators are still working it out.

The proposal that’s getting a lot of attention — and causing a lot of concern — would require (among other, less controversial things) a borrower make a 20% down payment in order for a loan to acquire QRM status.

Stop here. Keep in mind two things: 1) The “20% down” is just a proposal; and 2) Banks would still be able to lend money to anyone they chose, no matter what the down payment; they just wouldn’t be able to sell the loan to Fannie and Freddie unless they held onto 5% of it.

The idea is that Fannie and Freddie’s role in the secondary mortgage market would decrease in favor of private industry precisely because of such strict requirements. But it would also require that lenders who take a risk to assume the risk — and not pass it on to the goverment.

But it’s one thing to protect the taxpayers against risky bets by lenders. It’s another to make the QRM requirements so strict that loans become too hard to get or too expensive to afford. And that’s a big reason NAR is concerned about exactly what federal regulators will come up with.

To get the word out about the issue, NAR created a website explaining it all. Check it out.

(PS: Fun fact: “QRM” is the international ham amateur radio code for “Are you experiencing interference?”)

Corelogic misleads a bit on QM loans

A new report from CoreLogic claims that under the new Qualified Mortgage rules, half of the loans made in 2010 wouldn’t qualify.

But CoreLogic neglects to mention a very, very important piece of information, and that has led to a bit of hyperbole from the media that’s picked up the story.

Here’s the offending sentence, from CoreLogic’s February 2013 MarketPulse newsletter. Sam Kahter wrote:

It is estimated that only 52 percent of originations will meet the eligibility requirements of the QM rule’s safe harbor.

That tidbit was turned into headlines such as HousingWire’s “Only half of today’s mortgage originations meet QM requirements” and DSNews’s “CoreLogic: QM, QRM Rules Remove 60% of Loans, but 90% of the Risk.”

Wow. Thanks to QM, half of all loans will be denied!

Um… no.

Don’t miss the detail

The key, you see, is in the last part of that CoreLogic quote: “the eligibility requirements of the QM rule’s safe harbor.”

There are two standards of QM loans as defined by the Consumer Financial Protection Bureau: prime and subprime.

Subprime QM loans give lenders the same protections they have today — that is, a borrower can sue if he defaults and thinks the lender shouldn’t have given him a loan in the first place.

But a new standard, prime QM loans, give lenders extra protection — “safe harbor” from such suits, if the loan meets stricter requirements.

What CoreLogic found was that 48 percent of today’s loans wouldn’t meet the stricter standards that guarantee safe harbor for lenders. They would still qualify, if the lenders were willing to take the same risks that they take today.

It’s possible that some lenders will refuse to make loans that don’t meet those stricter standards. But they still can make sub-prime loans, and would have no more risk than they have today. So suggesting that almost half of all loans wouldn’t qualify at all is a bit misleading.

Here’s an analogy

Imagine the government makes a new rule: For every car a dealer sells that gets 50 MPG or more, he gets a $10,000 tax credit. Suddenly news stories come out, “75% of today’s cars wouldn’t meet new government standards!”

That’s slightly misleading. Maybe 75% of cars wouldn’t make the dealer eligible for that bonus, but they would still be sellable.

Same idea here. Maybe 48 percent of loans wouldn’t be eligible for the safe harbor ‘bonus,’ but they would still be qualified. Dealers may prefer to sell 50+ MPG cars, but that doesn’t mean they can’t sell others.

Finally, a translation

The bottom line is that this sentence:

It is estimated that only 52 percent of originations will meet the eligibility requirements of the QM rule’s safe harbor.

Should be read as:

It is estimated that only 52 percent of originations will qualify lenders for the extra protection to be offered under the safe harbor provision.

Then again, that doesn’t lead to headlines nearly as interesting.