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On Paper vs. in Practice – Implementing Dodd-Frank Rules

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By Ken Trepeta

mortgage_papers_signingAfter three years of rulemaking and organizing, the industry is finally experiencing the full-fledged implementation of the major Dodd-Frank rules affecting mortgages, in particular, the Qualified Mortgage or QM. A major question that needs answering is whether the rule in practice is the same as the rule on paper.

Industry fought hard for a safe harbor under the Ability to Repay/QM rule for good reason—there is significant potential liability for those not making QMs. Now that there is a safe harbor QM, will the risk managers allow lenders to go right up to the limits? Or will they impose more stringent standards to ensure lines are not crossed? Many have assumed lending will occur close to the limit, but in an industry burned by buybacks, will lenders take the risk?

We have already seen self-imposed tighter standards. One only needs to look at FHA. FHA rules say that one can make 3.5 percent down payment loans as long as the borrower’s credit score exceeds 580. If it does not, a 10 percent down payment is required. In practice, however, most lenders are not undertaking FHA loans for credit scores below 620 to 640, thereby adding their own safety layer.

While QM does not require a down payment, other elements of the rule are ripe for safety layering. The debt-to-income limit of 43 percent has this potential. While 43 percent can be exceeded for government loans, there is nothing that prevents lenders from imposing a limit themselves, or from using a lower limit for non-government loans. A lender could also impose other requirements for a non-QM loan that reduces risk exposure without necessarily making the loan QM. We are already seeing this with portfolio-held jumbo loans requiring high down payments.

Another area where lenders might add safety layers is the 3 percent cap on fees and points. Lenders might count things the CFPB doesn’t necessarily require them to count in calculating the cap, such as employee loan officer compensation. Or lenders could impose a stricter cap to give a cushion. It is not because lenders themselves want to limit their own risk by avoiding non-QM loans; they also want to make sure loans are QM so they can be sold easily on the secondary market.

A third area ripe for layering is the Annual Percentage Rate (APR) and Average Prime Offer Rate (APOR) cap. This cap basically says that a first lien will not be a QM if the APR exceeds the APOR by 1.5 percent or more. Clearly, lenders could impose a tighter APOR cap than 1.5 percent as well.

We hope that lending will not be significantly constrained by the QM rule, but it is certainly a possibility. However, it might only last as long as the market and lending industry need a breaking-in period. The bottom line is that the QM rule looks tolerable on paper—but will it be the same in practice?

This column is brought to you by the NAR Real Estate Services group.

Ken Trepeta is the director of Real Estate Services for the National Association of REALTORS®.

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