We can all remember the events that ultimately led to the dismantling of the private mortgage industry as well as reigning in mortgage giants Fannie Mae and Freddie Mac back in 2008. FHA loans were also affected as lenders were forced to enforce more rigid loan qualifying guidelines.
Actually, what lenders ended up doing was going back to the original underwriting guidelines they used prior to the introduction of so-called “stated” and “no income, no job” loans. As market conditions declined and lenders began a wave of foreclosures, it became apparent that the government had to step in and stop the bleeding.
In 2013, the Wall Street Reform and Consumer Protection Act was implemented, most often referred to as the Dodd-Frank Act in deference to the Congressman introducing the legislation. This legislation also created the Consumer Financial Protection Bureau, or CFPB. This newly created agency has sweeping powers and few other agencies have such broad authority.
As it relates to the mortgage industry, there were new specific guidelines that lenders were asked to follow. If lenders did so, they would receive certain legal protections from legal action they would otherwise not have. The CFPB set forth two rules referred to as the Ability to Repay and the Qualified Mortgage loan, or QM.
Ability to Repay
The guideline that affected most every conventional loan in the marketplace was the establishment of an ability to repay rule, or ATR. Mortgage lenders use debt-to-income ratios as part of the loan approval process. Prior to ATR, lenders approved some loan applications with debt ratios at 50 or even greater. This means a borrower’s monthly credit obligations, including the new mortgage, exceeded 50% of gross monthly income. Remember, this is gross monthly income and not take-home pay.
The CFPB established that lenders must third party validate the applicant has the ability to repay the new mortgage including property tax and insurance impounds by limiting the total debt ratio to 43. Now, lenders can certainly approve a loan with ratios higher than 43 but if they do the loan is not considered QM eligible and would be difficult to sell in the secondary market.
Loan Programs Eliminated
Part of the provisions of ATR mean lenders must verify monthly income. You may recall there were several types of loan programs where the income was not verified at all by the lender. If an applicant put $10,000 per month on a loan application the lender would use that income with no verification at all. The borrower simply “stated” the amount of income.
In addition, there were loan programs where no income was stated whatsoever and the income section was simply left blank. There was no need to verify employment. These loans, referred to as No Documentation loans were commonplace. Today, those programs are gone as well as the lenders who made them.
“Interest only” loans were also left out of the QM safety net. Interest only loans are those where the borrowers
have the option of making a payment toward interest but not paying down the principal balance at all. “Payment option” loans provided borrowers an option to pay the interest only, a minimum payment or a fully indexed payment. If the minimum payment was lower than the required interest payment, the loan balance actually got bigger, not smaller.
Today’s World
Let’s now fast forward to today. The lenders that are still around today did not engage in such risky lending behavior yet they are also the ones who are enduring the massive amount of new regulations set forth by the CFPB. In other words, the good guys are paying the price for the bad guys. When lenders sell a loan and the buyer claims there is a mistake, the original lender could be forced to buy back that loan. When lenders begin to buy back loans soon they’re out of the lending business…they have no cash or equity line available to make a home loan.
This keeps some borrowers on the sidelines for a completely “common sense” loan application that gets denied.
The additional guidelines and what many feel is unnecessary paperwork has led to increased costs in loan processing and underwriting. According to a study by the Mortgage Bankers Association, in 2005 an underwriter could approve more than 150 loans per month back in 2005 yet today because of the new guidelines, that number falls to 33 in the current environment. That means the mortgage company must hire four or five more underwriters in order to approve the same amount of home loans. This adds to the cost of the loan which is then passed on to the consumer.
And it’s not just the mortgage industry, the credit industry across the board makes it more difficult for well-deserving people to obtain loans not just to buy a house but to start a business or paying more fees for the very same loan.
Dodd-Frank : Say Bye-Bye?
Again, it’s the responsible lenders who are alive today. Loans are being approved using the same standards as always without the risky, faulty loan types that helped create the housing crisis. Thankfully that’s all in our rear view mirror but Dodd-Frank is still a behemoth of bureaucracy that many believe should be abolished.
President Trump recently declared that Congress should make financial regulatory reform a priority to “help striving Americans get the credit they need.” Vice President followed up by saying that dismantling Dodd-Frank is a top legislative priority and replacing it with the Financial CHOICE Act of 2017. The CHOICE Act includes tougher fines for Wall Street yet relaxes onerous restrictions placed on Main Street.
Unfortunately, Dodd-Frank was filled with good intentions but the end result appears to be the opposite of what was envisioned. Today, big banks are even stronger and more protected than they were before while the consumer is faced with more expensive loans that are harder to qualify for. The CHOICE Act is pro-consumer and has congressional backing. It looks like Dodd-Frank will soon be in our rear view mirror after all.
