The Wall Street Journal
By: Nick Timiraos
April 5, 2011
About one in five mortgages purchased by Fannie Mae or Freddie Mac over the 1997-2009 period would meet the proposed standard of "safe" mortgages that would be exempted from costly new lending rules, according to a federal report published last week.
Consumer advocates and the real-estate industry are preparing an all-out effort to soften new rules that they say create an overly conservative definition of "safe" mortgages that are exempted from costly new lending rules.
To recap: The Dodd-Frank Act requires banks to hold 5% of the credit risk of mortgages that are bundled together and sold off as securities. The idea is that banks and other issuers of securitized loans won't make poisonous mortgages if they have to eat some of their own cooking.
But regulators also defined certain gold-standard loans that will be exempt from those rules, which were put out for public comment last week. The current debate is focusing on just where those lines should be drawn.
Qualified loans would need to meet the following standards:
Buyers must make a minimum 20% down payment. Refinances and "cash-out" refinances would need loan-to-value ratios of 75% and 70%, respectively.
Mortgage-related debt could be no more than 28% of income and total debt couldn't exceed 36% of income.
Loans must be fully amortizing, which would bar interest-only and other more exotic products.
While there's no credit score cut-off, borrowers couldn't have missed two consecutive payments on any consumer debt in the past two years.
How conservative are these standards? Consider: About 62% of first mortgages taken out to purchase a home last year wouldn't have qualified because they had down payments of less than 20%, according to LPS Applied Analytics, a mortgage data firm.
A report by the Federal Housing Finance Agency, which regulates Fannie Mae and Freddie Mac, showed that around 31% of all mortgages that the firms bought in 2009 would have met the proposed standard for a "qualified residential mortgage." Prior to the housing boom, the years with the highest share of eligible "safe" mortgages were in 1998 (23%) and 2003 (25%).
The research only covers loans purchased by Fannie and Freddie, and the share of qualified loans that aren't backed by the agencies is even smaller because they generally had less conservative income standards.
The analysis shows the effect that removing any of the individual standards would have both on mortgage volume and on delinquency rates during the past decade. For example, removing the loan-to-value requirement for loans made in 2009 would have allowed 15% more loans to qualify while increasing the delinquency rate by 0.1 percentage points.
For now, these standards aren't expected to have a big pinch because they don't apply to federal agencies and because loan giants Fannie Mae and Freddie Mac will meet the risk-retention rules by virtue of their federal backstop.
But consumer groups and the housing industry are worried that the standards, which are tighter than those used by Fannie and Freddie, could eventually become the new definition of a prime, conforming mortgage. Loans that don't meet the new standards would be slightly more expensive because banks would have to hold more capital in reserve. The rules wouldn't apply to loans that banks hold on their balance sheets.
A report published Monday by analysts at Moody's Investors Service highlighted the risk that loans that don't conform to the standards are "labeled as second tier," requiring higher rates. On a $160,000 mortgage, an increase in the mortgage rate by 0.5 percentage points would represent just a 6% increase in monthly payments. But an increase in the rate by 2 percentage points would translate to a 24% jump in monthly payments.