FDIC Sets the Bar: QRM Exemption is 20 Percent

The FDIC established a new rule that will make it much harder to get a conventional loan without putting twenty percent down.

Dodd-Frank established an expectation that securitizers will have to retain more risk in home mortgages that they sell, providing that some loans could be exempted if they met a standard for conservative safe and sound lending. A debate then ensued about how high that bar should be. Some of the big banks, seeing an opportunity to use their size to a competitive advantage against smaller banks and credit unions, sought a ruling that would exempt only a fraction of loans. Wells, for instance, wanted loans to have at least 30 percent down before they were exempt. The administration sought a number of approximately 10 percent.

The FDIC split the difference.

When Senators Isakson, Hagan, and Landrieu wrote the QRM language in to Dodd-Frank, it seemed sensible. The rule did not just speak to loan-to-value criteria. It created firewalls against known problems: it curbs loans with stated-income documentation, negatively amortizing loans, and loans where debt-to-income was unreasonable.  Just a few years ago, the market seemed to have no “no.” Private MBS investors, along with GSEs, were ready to buy almost anything.

That didn’t work out so well.

The level of risk retention for loans issued outside of the “qualified residential mortgage” (QRM) threshold will likely be five percent. A loan that has to be held is a problem loan for many banks. The reason is relatively simple: holding a 5 percent loan for a long time, when the cost of capital is only about 140 basis points lower, is a poor investment. Add a few non-performing loans and suddenly it is a break-even proposition at best.

The Mortgage Bankers Association is very worried.  A letter by the MBA to regulators says that ” few loans to ordinary customers are likely to be made outside the QRM construct; the loans that are made will be costlier and likely to be made only to more affluent customers.”

The QRM rules will change the cost of lending significantly. An economist at BankRate said that a 30 percent exemption rule would have raised the cost of a new mortgage loan by 300 basis points. Even a 20 percent exemption should provoke a bump in lending costs. It might also mean that fewer lenders are willing to go long, hastening the disappearance of the 30-year mortgage. Shorter loan terms and higher interest rates will translate into lower sales prices on housing.