Richard Cordray of the CFPB declares "All American borrowers are stupid and we have to save them."
Well, he didn't use those exact words . . .
The CFPB is the Consumer Finance Protection
Bureau created by Dodd-Frank [Wall Street Reform and Consumer
Protection Act] (2010) to regulate America’s finance industry. It has
unquestioned authority, writes its own rules and can levy sizeable enough fines
to put a medium sized mortgage company out of business.
The CFPB’s new rules will dramatically
change mortgages beginning January 2014. The lynchpin of Dodd-Frank’s answer to
the mortgage crisis is called the “Ability to Repay.” By adhering to a set of
prescribed guidelines, the CFPB has created a “qualified mortgage” or QM. This
QM is supposed to help lenders escape government scorn and reprimand (which can
be very expensive for the offending lenders). But, to the casual reader, the
new QM seems to also avoid legal peril - borrowers that come back and charge
them with indigence; that is, failing to verify that the borrower could repay
the loan.
According the proposed rules (and keep in
mind that the CFPB proposes rules to itself and decides whether or not to
accept its own proposals), the CFPB has effectively created the model mortgage.
Deviate from it and a lender’s borrower can sue them to “forgive” the entire
loan. The only things that are unclear as of March 2013 are the exceptions. For
example, one theoretical exception is if the loan qualifies to be sold to
Fannie Mae or Freddie Mac. In other words, if the Fannie/Freddie automated
underwriting engines approve a loan (and an underwriter verifies that the loan
file meets the specified conditions of this automated approval), then the loan
is presumed to be a Qualified Mortgage.
What we do not know is to what extent Fannie’s and Freddie’s guidelines will
conform to the new QM rules. Inasmuch as there is only a “temporary” time
period in which Fannie/Freddie approved loans transcend this rule, it’s
virtually guaranteed that the first feature which the mortgage giants are
likely to adopt is the 43% rule; or, as I like to call it . . .
The
“Moron-Borrower” 43% Rule
To be fair, allow
me to quote from the CFPB bulletin.
Cap on how much income can go toward debt: Qualified Mortgages
generally will be provided to people who have debt-to-income ratios less than
or equal to 43 percent. This cap on debt ensures consumers are only getting
what they can likely afford. Before the crisis, many consumers took on mortgages
that raised their debt levels so high that it was nearly impossible for them to
repay the loan considering all their financial obligations. For a temporary,
transitional period, loans that do not have a 43 percent debt-to-income ratio
but meet government affordability or other standards such as that they are
eligible for purchase by the Federal National Mortgage Association (Fannie Mae)
or the Federal Home Loan Mortgage Corporation (Freddie Mac) will be considered
Qualified Mortgages.
Before you decide whether 43% is too cold,
too hot or juuuuuust right, consider
-
The old fashioned total debt ratio was 36% (27% housing
obligation ratio; 36% total debt including housing ratio)
-
In the past 10 or more years, Fannie’s and Freddie’s automated underwriting
systems routinely approved debt ratios of up to 60% and I’ve seen even higher
than that.
-
Currently, Fannie, Freddie and HUD (for FHA, which used
Fannie/Freddie underwriting engine) are approving debt ratios as high as 55%.
-
Foreclosure rates have dropped dramatically in the past three
years; from their high point in 2010, they are now lower than at any time since
the crisis began in early 2007. While there are many factors that contribute to
this, tightened underwriting standards are being given some of the
credit. This is a somewhat dubious claim since it is rarely newly financed
homes that go into foreclosure. A longer timeline is necessary to measure the
effect of underwriting standards on foreclosure rates. But, we cannot deny that
there is some cause and effect. Clearly, the underwriting giants have taken
maximum debt ratios into account when setting the parameters of loan approvals.
This means, then, that debt ratios of higher than 43% pose no hard-and-fast negative
factor to Fannie/Freddie/FHA.
-
43% total debt ratio leaves fewer dollars left over as “disposable”
income for a lower income earner than for a higher income earner. For the
income earner making $2,000/month, $1,140 is “left over” after 43% goes to
debt. For the person making $10,000 per month, $5,700 is “left over.” And this
is after taking into account the Jaguar payments. One can only pay so much for
a pound of chicken. Which bring me to . . .
More importantly, it’s really not the 43%
rule; rather, it’s the 57% rule. Consider the following excerpt from the
proposed rules. Under Types of Qualified Mortgages: Qualified Mortgages with
rebuttable presumption, the
borrower has recourse if “the creditor did not consider their living
expenses after their mortgage and other
debts.” [emphasis mine] This means that the lender no longer just
considers the now-famous “debt to income ratio” but the remaining income both as
a dollar amount and a percentage of total income.
If you thought borrowers were frustrated
with increased demands for more and more documentation, wait until we tell them
there is an upfront charge of $750 for an independent CPA’s audit of the last
two years of their personal finances; that is, enough information to underwrite
the remaining 57% of gross income.
To truly take this rule into account and in
order to prevent lawsuits, lenders will need to know what households spend on
cable TV, groceries, restaurants, church and charitable contributions (some
people give 10% and more of their gross income to “charities”), school
fees/tuitions/supplies, gymnastics or cheer activities (have you seen the
thousands of families whose lives nearly center around their child’s
cheerleading or gymnastics?), clothing, work or union dues/expenses, vacations,
sports, gambling excesses . . . the list is inexhaustible. And higher income
earners have a whole range of other “high-dollar” activities. In order to keep
a child in the equestrian sport or advanced “go-kart” racing, parents could
easily spend $10,000/month or more.
And underwriters can only measure the past
as a way to predict the future. So, what and how your clients are spending right
now may well affect their loan approvals next year.
It is my view that the greatest fault of
this rule is the “moral hazard.” It removes the responsibility for financial
decision-making from the borrower and places it, nearly, solely upon the
lender. This is not to say that the lender should not set its own standards. It is
to say that folks with good credit are often qualified to borrow more money
than they have good sense to borrow. And, one of the major reasons they are a
(credit, income and asset) qualified borrower is because they have exercised
that good sense. It is likely that this sort of consumer will continue to
exercise good sense. But, economic moral hazards are about incentives. And the CFPB’s
rule introduces the wrong sort of incentive – that of placing nearly all of the
responsibility for spending too much or too little on goods and services with the
creditor, and virtually none of it on the borrower.
That’s why I call it the “Moron-Borrower”
rule. The all-superintending state assumes that all borrowers are morons and
completely indigent, ill-motivated ones at that. Moreover, the rules assumes that it is the state's role to save American borrowers from themselves.
Divorcing/divorced borrowers will be
especially affected. To date, those little extra elements in a decree that
order spouses to pay certain fees, tuitions, health insurance premiums and
innumerable other expenses have not been counted in a borrower’s debt ratio
calculation. Only child support and alimony or spousal support payments (and
sometimes loan repayment to ex-spouses) have been counted in debt ratios
(either as income or as debt). I expect that lenders will be required to either
count those heretofore excluded obligations in the debt ratio (maximum 43%) or
will have to consider them in the remaining 57% calculation.
So, remember that it is really not the 43%
rule. It’s the 57% rule.
A bit of a rabbit trail here but still
relevant. Income (one half of the debt-to-income ratio) is likely to be
scrutinized more severely – especially support income. Up until this past
October, both conventional and FHA loans typically required a “pay history” of
only 3 months in order for child or spousal support to be considered “qualifying”
income. (That, and the other requirement that such income continue for 3 years
after loan closing were the 2 factors that produced “qualifying” income).
Conventional loans now require a pay history of 6 months and, in theory, may
require up to 12 - 24 months of such history. FHA guidelines still allow for a
3-month pay history but I expect that to change as underwriting guidelines are
evolving into a monolithic, government-sanctioned tablet from Mt. Sinai.
Well, let me ask you. When the feds (CFPB) really
look at the fact that the demographic that is most likely to default on their
mortgage debt is the newly-divorced mother, how do you
think they will rule on the matter?
It is more important now than ever that
those who are even considering divorce immediately begin my pre-divorce strategy
that will allow both parties to qualify for their next mortgage; whether it is
for refinancing or purchasing. Else, they will be waiting for a minimum of 3
months longer for their financing – not good for many clients who have to
purchase immediately after final divorce using support income to qualify.
Please give me your comments and follow-up
questions. I enjoy hearing from you and will take the time to respond thoughtfully
and responsibly. noel@themortgageinstitute.com
or 817-454-4555.
Noel Cookman
