A Supreme Court decision that will set a legal precedent for financial firms trying to meet the new requirements set forth in the Fair Housing Act is approaching. And new research suggests that policymakers should not impose requirements beyond certain qualified residential mortgage thresholds. In February, the nation's highest court will hear Magner v. Gallagher, a closely watched case because the qualified mortgage and QRM lending rules remain undefined by various federal regulators. There is an urgency to get a decision on this matter as the lending industry goes through a period of regulatory reconstruction. The QRM proposal by regulators that defines a high-quality mortgage as one with at least a 20% down payment would hobble a healthy segment of the housing market, according to the Center for Responsible Lending. While higher down payments do result in fewer defaults, the payoff is small relative to the number of creditworthy households that could be shut out of the market, the CRL report shows. The study examined the way different QRM guidelines would affect loan performance and access to mortgage credit, looking both at the entire market and the impact on historically underserved households. Researchers calculated the benefit ratio for possible QRM underwriting restrictions that impose a combination of loan-to-value, FICO score and debt-to-income thresholds on QM loans. They evaluated three hypothetical combinations: one with very strict underwriting criteria (80% LTV, FICO above 690, and DTI of 30%); one with more relaxed underwriting criteria (97% LTV, FICO above 600 and DTI of 45%) and one in between (90% LTV, FICO above 660, and DTI of 36%). Researchers found that the least restrictive guidelines — the second option — produced the best ratio in that it only excluded eight creditworthy borrowers for every one default that it avoided. They found that the strictest guidelines produced the worst ratio with 12 creditworthy borrowers excluded in avoiding one default. "The most restrictive thresholds are less effective because they exclude a larger share of borrowers in relation to percent of defaults they prevent," the CRL said. Click on the chart below for a comparison of how different QRM underwriting thresholds might impact borrower access to loans. "These excluded borrowers represent households that have not gone into foreclosure, indicating that unduly restrictive underwriting guidelines could bar borrowers who can be successful homeowners from obtaining a QRM mortgage," the researchers said. Additionally, the study found that imposing additional LTV, DTI, and FICO underwriting requirements on QM loans has disproportionate effects on low-income borrowers and borrowers of color. At the most restrictive combined thresholds, the vast majority of creditworthy borrowers — about 85% — would not qualify for a QRM mortgage, the researchers said, with the impacts greatest for creditworthy blacks at 93% and Hispanics at 91%.
"Our research provides compelling evidence that the QM product loan guidelines on their own would curtail the risky lending that occurred during the subprime boom and lead to substantially lower foreclosure rates, while not overly restricting access to credit," the study concluded.
Write to Justin T. Hilley. Follow him on Twitter @JustinHilley.