Mortgage definition could restrict options

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Government regulators are about to define a “qualified residential mortgage,” and their definition could determine the types of loans homebuyers and homeowners will — and won’t — be able to get.

Some experts see no upside for borrowers. Others hope that the definition will help borrowers get home loans that are less likely to result in hardship or default.

“The whole purpose” of the new definition, says Ellen Harnick, senior policy counsel at the Center for Responsible Lending, speaking from the Washington, D.C., office, “is to encourage responsible loans and discourage the types of loan we’ve seen blow up.”

Here’s a summary of what borrowers need to know:

  • The qualified residential mortgage, or “QRM,” definition is a requirement of the Dodd-Frank financial reform act. Mortgages that meet the definition won’t be subject to a rule that lenders must retain 5 percent of the risk on any loans they originate.
  • Six federal agencies are supposed to cooperate on the definition, which is due by mid-April. The risk-retention requirement goes into effect one year after the final rule is adopted, or spring 2012 at the earliest, according to the Mortgage Bankers Association.
  • Mortgages insured by the Federal Housing Administration and loans guaranteed by the Department of Veterans Affairs are exempt from the risk-retention requirement. The QRM isn’t applicable to them.
  • The QRM definition could be broad or it could be narrow. A broad QRM definition could encompass the sorts of mortgage products borrowers were offered before the housing boom, such as 30-year fixed-rate mortgages, 15-year fixed-rate mortgages, adjustable-rate mortgages, or ARMs, as well as 5/1, 7/1 and 10/1 hybrid mortgages. Left out would be payment-option loans, interest-only loans, balloon-payment loans and the like.A narrow QRM definition could be restricted to just one type of mortgage, say, a classic 30-year fixed-rate loan.
  • The breadth or narrowness of the definition will be crucial because borrowers who fall into the gap between the QRM and an FHA or VA loan could face fewer choices or higher interest rates, according to Ken Trepeta, director of real estate services at the National Association of Realtors. If the definition is broad, the gap will be small and the status quo will continue. If the definition is narrow, the gap could be a chasm and change could be dramatic. “You are going to see tightening credit, and people in general will have less access to affordable mortgage credit a year from now, if they go with a tight QRM,” Trepeta says.
  • The QRM may address such issues as documentation of the borrower’s ability to pay, the borrower’s debt-to-income ratio, the potential for ARM payment shock and mortgage insurance, among other factors. The two most controversial components are down payment and loan servicing requirements.

“The down payment is really the decision point,” Trepeta says. “What should the down payment be? There will probably be other parameters, but that’s the talk of the town.”

Wells Fargo, one of the largest U.S. lenders, reportedly supports a 30 percent down payment requirement. Trepeta says that would “at least delay” prospective homebuyers who could afford a mortgage payment, but couldn’t save up tens of thousands of dollars to put down.

A hefty down payment requirement probably wouldn’t eliminate non-FHA small down payment loans, but those loans would be subject to the risk-retention requirement. Harnick says only a smaller group of lenders presumably would be in a position to make those loans.

“From the point of view of a borrower who’s not in a position to make a large down payment, it should sound a cautionary note that this is a potential outcome,” she says.

Some agencies and groups want to wrap loan servicing into the QRM definition as well. The chief argument in favor of that approach is that servicers should be required to offer borrowers reasonable alternatives to foreclosure, among other concessions.

“It’s unreasonable to expect that loan servicers are going to do everything you might want them to do to make your life easier, but certainly, you want to know you’re going to be treated fairly,” Harnick says.

The main arguments against this approach are that the QRM isn’t the right vehicle to accomplish the objective and that such servicing requirements would apply only to loans that met the QRM definition and were originated after it became effective. That would create a two-tier structure in which loan servicing protections would apply to some, but not all, loans.