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This article analyzes the proposed definition of the qualified residential mortgage (QRM), and how it will affect the future of California real estate.

Strictly speaking…

Defining the qualified residential mortgage (QRM) is testing the mettle of the government’s commitment to stability in the real estate market.

QRMs, established under the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank), are loans meeting low-risk standards which exempt lenders from having to retain any part of these loans in their portfolios. [For more the broad QRM definition established under Dodd-Frank, see the October 2010 first tuesday Legislative Watch, TILA circa 2010; consumer protection enhancement.]

New proposals by federal agencies and the administration restrict the designation of QRM to loans in which homebuyers put down at least 20% of the purchase price of a home as down payment, colloquialized as “having skin in the game.” [For first tuesday’s analysis of who has skin in the game, see the April 2011 first tuesday article, Whose skin is in the game?]

The proposed down payment requirement alone has sparked fierce debate in real estate circles and the media, but it’s far from the only proposed restriction on what qualifies as a QRM. The designation of QRM is restricted to:

  • first-lien mortgages to purchase or refinance a one-to-four unit principal residence;
  • mortgages amortizing over 30 years or less;
  • borrowers who are not currently 30 or more days past due on any debt;
  • borrowers who have not been 60 or more days past due on any debt within the last 24 months;
  • borrowers who have not, in the past 36 months:

o   filed for bankruptcy;
o   had property repossessed or foreclosed on;
o   engaged in a short sale or deed-in-lieu of foreclosure; or
o   been subject to a federal or state judgment for the collection of a debt;

  • loans with interest rates adjusting no more than two percent in any 12-month period, and no more than six percent over the life of the loan, if the loan is an adjustable rate mortgage (ARM);
  • mortgages which do not contain prepayment penalties;
  • loan-to-value ratios of 70% for rate-and-term refinances and 75% for cash-out refinances;
  • debt-to-income ratios of 28% for all mortgage debt, called the front-end ratio, and 36% for all debt, called back-end ratio;
  • standard documentation loans;
  • loans with points and fees of 3% of the loan amount or less; and
  • non-assumable loans.

Any loans not meeting all the above requirements would require lenders and securitizers to hold in reserve an amount equal to 5% of the loan balance in their portfolios, as recovery funds in case of default. This means any borrower who does not qualify for a QRM — i.e., the vast majority of borrowers — would be subject to higher interest rates to cover the increased risk a non-QRM would pose to lenders.

Federal Housing Administration (FHA)- and Veterans Administration (VA)-insured loans, as well as loans sold to Fannie Mae or Freddie Mac (while they remain under government control) are not subject to the QRM requirements under the proposal.

If passed, the rules outlined in the proposal will not be implemented until mid-2012.

The zero-sum game lenders will play

Will restricting short-sale participants from being eligible for a QRM really lead to fewer people overpaying for their homes or defaulting?

Ah, lenders. The idea of retaining any risk for the loans they originate has them running a bit scared. At this point, we can only speculate on what tricks lenders will devise to get around the rules that borrowers and the rest of the consuming public have to play by — and make no mistake, lenders will do so. [For more information on lenders’ uneven playing field, see the April 2011 first tuesday article, Retribution deferred: lenders prove too powerful to be prosecuted.]

Many of the proposed QRM requirements would set groundwork for a stable housing policy (down payment requirements, strict DTI ratios), separating those who are truly financially able to take on the burden of homeownership from those who are tenants-by-nature. However, it’s important to note the distinction between QRM and a non-QRM are not prohibitive; lenders can still lend to non-QRM-eligible borrowers.

And Americans still have a huge appetite for homeownership in spite of the unmanageable financial risks it poses to most homeowners. A recent study shows Americans are still very willing to glut themselves on housing and mortgage debt, regardless of the financial malaise which follows. Thus, the strict definition of the QRM will only lead to more marginalized types of borrowing — the non-QRM-eligible borrowers will almost certainly be charged higher interest rates, thus perpetuating the cycle of non-QRM-eligible borrowers being more likely to default. [For more information on how the American dream of homeownership is faring, see the April 2011 first tuesday article, Americans dream for a home on unstable ground.]

Likewise, the three-year restriction against borrowers who participated in a short sale or deed-in-lieu of foreclosure carries the weight of punitiveness by classification, not ability to pay. Borrowers may have taken it upon themselves to buy (or refinance) when the market value of their properties were worth more than fundamentals dictated, but lenders had no qualms about originating these loans at the time, knowing quite well their conduct was a financial accelerator recklessly driving home prices up. Will restricting short-sale participants from being eligible for a QRM really lead to fewer people overpaying for their homes or defaulting?

Solution or punishment?

The importance of a stable housing policy promoting stable homeownership is paramount, but the strictness of the QRM may be based on reactions to the most recent housing crisis rather than truly crafting a stable housing policy. The strict differentiation between QRMs and non-QRMs merely gives lenders the ability to pawn off their 5% risk-retention onto underqualified homebuyers and homeowners; it’s a zero-sum risk reduction for lenders.

Brokers and agents would do well to be aware of how this proposal fares in the coming months. The proposal is open for comment through June 10, 2011. Comment can be submitted to any of the participating agencies via methods outlined on pages two and three of the proposal, which can be read in its entirety on the Federal Deposit Insurance Corporation (FDIC)’s website.