Mortgage

Will CFPB's QM proposal create a brand new actual property bubble?

The Consumer Financial Protection Bureau's proposed revision of its mortgage insurance rule alarms critics who say it will lead to another housing bubble. One commenter even claims the plan will violate fair lending laws.

The agency proposed in June that instead of the current debt-income limit, a price threshold be used to determine which loans are qualified mortgages and are therefore protected from liability. Lenders have argued that the current DTI limit of 43% is too restrictive. The new plan would grant QM status to loans capped at 150 basis points above the prime rate.

However, free market proponents and others fear that the new QM standard will inundate the market with unaffordable credit and fuel defaults in a rerun of 2008.

"The use of margin (average prime offer rate) can destabilize mortgage markets and lead to episodes of increased crime similar to the financial crisis," said Susan Wachter, professor of finance and real estate at the University of Pennsylvania's Wharton School.

Ed Pinto, a resident employee and director of the Housing Center at the American Enterprise Institute who has long advocated conservative housing, has gone a step further. He has asked the CFPB to forward its proposal to the Department of Housing and Urban Development, which can investigate possible violations of the Fair Housing Act.

In a recent letter of complaint to CFPB director Kathy Kraninger, Pinto said the proposed APOR price threshold was compatible with higher arrears for black and Hispanic borrowers compared to white borrowers.

"Once you remove the DTI requirement, even more minorities will have even higher arrears than non-minorities, and so the proposed rule has a discriminatory effect," said Pinto, former chief credit officer at Fannie Mae, in an interview.

It can be difficult to determine if someone is falling behind or falling behind until a stressful event causes job loss or other financial problems. The coronavirus pandemic provided the stress Pinto needed to analyze whether crime rates would disproportionately harm minority borrowers.

Using the data from the Home Mortgage Disclosure Act, Pinto found that loan rates on loans to black and Spanish borrowers in 2018 and 2019 were 14.2% at 100 basis points above the APOR and 16.7% at 150 basis points in July 2020 lay. For comparison, the crime rates for white borrowers were 9.4% and 11.4%, respectively.

"The facts regarding the CFPB's rules-setting practices suggest a pattern or practice of discrimination that violates the Fair Housing Act," Pinto wrote in the letter.

However, it is not clear whether the CFPB will forward Pinto's complaint to HUD, and some observers question the link between the APOR threshold and fair lending rules.

A recent Urban Institute paper recognizes that higher credit prices result in more arrears, regardless of a borrower's demographics.

"Our analysis found that all measures of default are highly correlated to interest rate spreads," wrote Laurie Goodman, vice president of the Urban Institute's co-director of housing finance policy, in the paper.

Dave Stevens, the CEO of Mountain Lake Consulting and former commissioner of the Federal Housing Administration, was more explicit.

"I don't think (Pinto's) view holds water," said Stevens. "Ed is on a kneecap mission (Fannie Mae and Freddie Mac) and he's using this distorted view that government programs harm minorities."

When Congress passed the Dodd-Frank Act after the financial crisis, it created a category of ultra-secure QM loans that provided legal protection to lenders. Dodd-Frank requires lenders to verify a borrower's ability to repay a mortgage and eliminate most of the risky credit features such as teaser rates and balloon payments.

Kraninger released a QM proposal in June to replace the hard DTI rate of 43% – the key subscription requirement when the rule was issued in 2013 by then-CFPB director Richard Cordray, one of Obama-nominated – with the price metric that both the mortgage industry and consumers are in favor of assistance.

Under the proposal, lenders borrowing with interest rate spreads no more than 150 basis points above the APOR for a comparable transaction would receive what is known as a safe haven against claims that a lender does not meet the repayment standard. The APOR interest rate spread is the difference between the annual percentage of a loan and the average prime offer rate as reported by federal regulators.

But Pinto, who has long been an opponent of credit easing through low down payment mortgages and higher debt-to-income ratios, believes that having so little inventory in the housing market will allow borrowers to get into more debt leads to an increase in property prices.

"This will hurt protected-class borrowers as it allows riskier loans to be made," Pinto said. "If you have a shortage of housing and you are increasing the leverage, which APOR + 150 will do, it means you are making riskier loans. However, if you haven't done anything to expand the housing supply, it is all in the end, which means that outbid each other with leverage, which increases real estate prices even further. "

Still, many others consider the QM rule proposed by the CFPB to be a step in the right direction as it aims to reduce the government's oversized role in the property market.

"What the CFPB has proposed, while not perfect, is really the only viable solution to ensure we have a system that does not unnecessarily hamper banks and credit unions," said Stevens.

The office is under significant pressure to replace the current 43% debt-income limit with another method of determining QM.

The original CFPB rule provided a temporary exemption for government sponsored businesses known as the GSE patch that allowed Fannie and Freddie to purchase loans with DTI rates above 43%.

Banks and mortgage lenders have worked hard to remove any DTI requirements, claiming the 43% cutoff would capsize the property market. In a rare balance of interests, consumer advocates agreed with lenders, as many minorities with high debt loads would be excluded from the market if nothing was done after the GSE patch expired.

In the six years since the QM rule was finalized, the GSEs have dominated the mortgage market. Banks and lenders sold around 957,000 loans to Fannie and Freddie with DTI rates above 43%. If the patch expires without needing to be replaced, between 15% and 20% of borrowers cannot get credit.

The CFPB has also proposed higher price thresholds for smaller loans, which the bureau says are especially important for prefabricated homes and minority consumers.

However, some experts agree with Pinto that the CFPB's proposal to base the rule on a price cap would hurt some minority borrowers, especially during a financial downturn.

"It is likely that the likelihood of a bubble and bust will increase, and we know from experience that bubbles and busts are more likely to affect marginal homebuyers," said Wachter.

The GSE patch is set to end in January 2021, or when Fannie and Freddie leave the Conservatory, whichever comes first. (Other government-secured loans, such as those insured by the Federal Housing Administration, are similarly exempt.)

Kraninger has promised a smooth transition for the mortgage market with the GSE patch expiring at the time a final QM rule comes into effect.

Pinto filed the complaint under an executive order of 1994 designed to ensure that government programs and activities related to housing and urban development are managed in a way that positively supports the goal of fair housing under the Fair Housing Act.

He said Kraninger was required to send the complaint to the HUD, which could forward it to the Justice Department.

The CFPB declined to comment.

The mortgage market is in turmoil this year and few lenders expect the CFPB proposal to change that direction. Low interest rates have sparked a huge refinancing boom while the coronavirus pandemic has pushed many shoppers to move to less crowded communities and homes with more space.

While Pinto may be one of the few votes against the QM proposal, he sees more problems ahead.

"If you want to know why minorities and low-income families are unable to build wealth, it's because they are usually the last to hit the market, then house prices peak and collapse, and they are being repressed and that takes time. " Years until they come back and start the roller coaster cycle all over again, "he said.

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