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Lending

Ability-to-repay rule: The good, the bad and the ugly

Discover Home Loans economist: 10% to 12% of loans won’t qualify under QM

Home Prices

In the coming weeks, consumers may find out just how limiting some of the new Dodd-Frank lending era rules feel when in practice.

What could shock them, analysts say, is the realization that obtaining a mortgage in the ability-to-repay world is going to be difficult if they come to the table with a certain credit profile. 

Lenders for the most part know what’s coming. After all, they’ve spent the past two years building out platforms, implementing compliance management systems and tapping into the latest technologies to ensure compliance with Consumer Financial Protection Bureau-defined rules.

But consumers remain mostly in the dark, industry experts warn.

Some of these same consumers are about to discover that a small – yet significant part – of the American public is going to struggle in obtaining a mortgage. 

The biggest hurdle is the 3% points and fees cap – a new lending rule requirement that will force lenders who don’t have the technology infrastructure to adequately capture all points-and-fees to take a very conservative stance when lending, says Cameron Findlay, chief economist for Discover Home Loans. They won’t want to miss anything, so any borrower who nears the 3% cap could lose out at capturing a mortgage at any lending shop without the best technologies in place.

He estimates that 10% to 12% of loans in the marketplace fall outside the new qualified mortgage rule definition – a steeper estimate than the 5% provided by Richard Cordray, director of the CFPB. 

Even still, if it is 5%, Findlay says, "5% in reality is a huge number of people out there in the marketplace."

And if a lender is not confident enough to ensure internal technologies can provide them with an exact points and fees estimate, then "they will take a very conservative stance," says Findlay.

As a result, they will say anything near the 3% cap is out, he adds.   

"Most lenders will hedge on the side of being more conservative," he explained, noting that "those with tech infrastructures in place will be able to look at all of the components of the mortgage."

Digging deeper into the rules, the guidelines are more nuanced than one might expect, creating additional issues, Findlay points out.

For example, take the average prime offer rate, which is issued at the end of each week. It re-sets weekly. And based on rates set, a borrower may not qualify one day, but "as a function of the re-setting, you could qualify the consumer on Monday. That is a gaping hole in the rule," Cameron says.

But a much bigger issue becomes the loan-level price adjustments as set by the Federal Housing Finance Agency, the Discover Home Loan economist points out.

These adjustments define the FICO and loan-to-value grids and basically determine the risk.

"Those loans that are most at risk will have to apply the most points, and that will cause them to break through the caps on points and fees,” Findlay told HousingWire.

Even though Rep. Mel Watt, the new FHFA director, said he would delay adjustments to loan-level pricing, it’s just a delay, the economist points out. Eventually, guarantee fees and loan-level pricing adjustments are going to have to rise to bring private capital back into the market, and that is going to hurt low-to-moderate-income borrowers, he explains. 

Findlay says in 90% of the cases where consumers are failing the qualified mortgage test today, the borrowers are breaking through the cap on points and fees.

Parts of the country, such as Atlanta, may feel the impact the most, Findlay noted. "When I look at mortgages in Atlanta, about 38% of homes there have negative equity."

He adds that roughly 66% have LTVs greater than 120%. The result is a large quantity of people with a higher LTV score, so when they go to refinance, they will have more points applied making it more likely they will break the 3% cap on points and fees.

The good news is that "for 90% of consumers, it will have no impact at all," Findlay says. "But for the 10% who don’t qualify it is going to be very difficult for them to understand why."

No longer can the lender say go raise your FICO score and come back. "With this, it could be a function of the fact that it’s a combination of different elements, so it is more difficult to fix for a consumer," Findlay explains.

It’s not just Findlay advising the consumer market about the coming changes.

Roelof Stump, managing director for Fitch Ratings, put out a report and a correspondent video about the ability-to-repay rule's impact on borrowers.

"It is likely that the 43% debt-to-income standard may cause some borrowers to fall short of qualifying for the amount of loan needed for the price of the house that they are interested in buying," Slump wrote. "Also, some higher net worth buyers may find that higher down payments will be needed on their higher value homes, in order to keep their debt-to-income within guidelines. This might have a more notable impact in certain higher-priced areas of the country like New York City as well as areas of California such as San Francisco and San Jose."

There is potential for the market to experience higher rates on loans that fall significantly outside the QM standards. Like Findlay, he also sees an impact on moderate-income families.   

"Over time, the potential exists for higher rates on loans deviating significantly from the QM standard. Also, existing tight underwriting guidelines may limit purchases by moderate income families, which the new rule may not be able to fix," Stump wrote. "Furthermore, the inclination by lenders to make non-QM loans will also be influenced by the market's willingness to buy such loans or provide financing secured by them."

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