Tuesday, April 19, 2011

I’m Here From the Government and I’m Here to Help

The Qualified Residential Mortgage
By Greg Parrish

The Federal government is in the process of changing the guidelines of purchasing residential real estate. The FHFA (Federal Housing Finance Authority) and a group of real estate industry organizations have produced white papers that speak to QRM. The Qualified Residential Mortgage has emerged from the Dodd-Frank Act like ketchup does when stepping on the packet. It’s all about “risk retention”. It will affect a broad range of asset types, but has gained the most notoriety by requiring mortgage lenders to have some “skin in the game” after the mortgage loan has closed and funded. The proposal would establish a definition for QRMs, which will incorporate such criteria as borrower credit history, payment terms, down payment for purchase mortgages, loan-to-value ratios, and debt to income ratios. All this is designed to ensure mortgage loans are of the high credit quality. QRM will affect the real estate industry in a big way. There are three aspects that warrant additional scrutiny.

1. It will require that lenders retain 5% of the purchase price if the borrower places less than 20% down

2. To obtain the best market interest rates, debt to income ratios will be kept at a mandatory cap of 28/36

3. To obtain the best market interest rates when refinancing you must have at least 25% equity in your property. If you want a cash/out refinance you must have 30% equity position.

The big exception is mortgage loans with a Federal guarantee as FHA, VA, and Fannie Mae & Freddie Mac (until they emerge from conservatorship). In today’s market, government guaranteed loans comprise virtually the entire mortgage market. So, the silver lining is that, right now, the effect will be minimal. But, when it does take effect, most likely sometime in 2012, it will impact your ability and the way you purchase real estate.

By requiring mortgage lenders to retain 5% of the loan amount after the loan closes and funds, interest rates will necessarily increase to off-set the “loss” of capital available to earn interest. Higher interest rates will make it more expensive to get a mortgage.

Capping the borrower’s debt-to-income ratios at 28/36 to obtain the best interest rate will have the effect of closing many potential homebuyers out of the market. While most would be homebuyers would love to have a debt-to-income ratio as prescribed, the reality is that most are somewhat higher. Forcing a higher interest rate on homebuyers with a debt-to-income ratio of say 29/39 is preposterous! These caps will needlessly increase the monthly mortgage costs of millions of homebuyers and make it more difficult to qualify for their mortgage, even if they had they requisite 20% down payment.

Considering just these two aspects of the Dodd/Frank Act (we haven’t even discussed how this affects refinancing or what is expected of a person’s credit report) would due such damage to our industry and the economy as a whole that to say it would screw tight the lid on coffin of the real estate industry, in my opinion, would be a massive understatement.

The conundrum is that the groups of borrowers who will be hit the hardest are the first time homebuyers and those with moderate incomes. These are precisely the groups that the Feds wanted to help purchase a home in the first place! The pendulum has swung about as far in the opposite direction as it can.

Public comments are being accepted by the Federal Reserve until June 10th, 2011.

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