A decision by government regulators on an obscure issue next month could have a big impact on mortgage rates and home loan products available to borrowers.
Under the Dodd-Frank Act that overhauls regulation of the country’s financial system, mortgage lenders must share losses on their loans. But if their mortgages are deemed safer “qualified residential mortgages” they don’t have to have their skin in the game.
Mortgage products that don’t fall into the qualified residential mortgage category will probably have higher mortgage rates and tougher qualification standards for borrowers.
Congress, which typically doesn’t get into the details of the laws it makes, didn’t define a qualified residential mortgage. Instead, it left it up to regulators, who are now grappling with the issue.
Regulators, expected to reach a decision next month, have been getting an earful from lenders, investors and housing advocates on how to define qualified residential mortgages. Most groups agree to exclude the riskiest mortgage product like negative amortization loans, but beyond that, they disagree on what to call a safe mortgage.
Regulators have a lot to think about. Take down payment amounts, for instance. A recent article by MarketWatch says large banks want a large down payment requirement of 30 or 20 percent. Small banks want a small down payment requirement of about 5 percent, and housing advocates want to allow even smaller down payments of 3 percent.
Credit scores, income to debt ratios, length of employment, and the amount of documentation are some other factors to consider.
Depending on the regulators’ ruling, many mortgage products or just a few will be defined as qualified mortgages and be exempted from risk sharing requirement. Criteria that are too strict will risk barring many borrowers from low mortgage rates, but if guidelines are too loose lenders might be free to again make risky loans.
When the real estate market bubble was building, some mortgage lenders gave risky, exotic home loans to borrowers, then bundled the mortgages into bonds that were sold to investors who took the hit when borrowers defaulted. The theory is that lenders will be more cautious about making riskier loans if they retain part of the risk, or have skin in the game.
In addition to bank regulators, the Treasury Department, the new Financial Stability Oversight Council and the new Consumer Financial Protection Bureau will be involved in creating the rule.