When the federal government began giving billions of dollars to the banking industry through the Troubled Asset Relief Program (TARP), we discovered that many financial institutions had gotten themselves into their dire situations by making or investing in high-risk home loans. Subsequent to that discovery, there was a push to reform residential lending practices.
One piece of legislation aimed at curbing such high-risk lending for homes is the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. In part, this law gives federal bank regulators the authority to set mortgage lending standards to attempt to prevent the lending mistakes of the past. Using this authority, the newly empowered regulators have created a new Qualified Residential Mortgage (QRM) standard and proposed guidelines to govern it. This standard is meant to increase the number of loans that are of high credit quality and have a low likelihood of default.
According to the Community Associations Institute, as proposed, these QRM loans require that a person be able to provide a 20 percent down payment (or more), pay full closing costs out-of-pocket, provide full income documentation, and be current on all existing debt payments. Additionally, applicants are subject to strict debt-to-income ratio limitations, must not have been more than 60 days delinquent on a debt obligation for two years, have had neither property repossessed nor been party to a bankruptcy proceeding, foreclosure, short-sale, or deed in lieu of foreclosure within the last three years, and have never been subject to a Federal or state judgment for collection of any unpaid debt. QRM loans are also only available as first-lien mortgages for a purchaser’s primary residence or second-liens for refinancing existing loans. Finally, adjustable rate mortgages are only to be adjusted only twice per year, and those adjustments cannot exceed six percent during the life of the loan.
The new guidelines impose much stricter standards than previous lending practices. For example, previously closing costs (which can be several thousands of dollars) could be financed. The 20 percent down payment requirement is perhaps the greatest change, as it doubles the 10 percent down payments that were routinely made by first time home buyers in previous years. What is so onerous about saving up the amount needed for closing costs and down payment, like we all used to? In addition, if buyers have more invested in their home purchase, they are less likely to just walk the loan, as so many have done.
The Dodd-Frank Act, ironically, was brought to you by the same legislators who forced Fannie Mae and Freddie Mac to lower their standards for the mortgage loans they purchased in the first place. Those decreased standards bear the primary responsibility for the housing “boom” and subsequent bust. This Act has many, many problems, but increasing the investment needed for a house purchase is not one of them.