Mortgage Lenders Tighten Requirements Ahead of QM Rule

When Mitt Romney mentioned the so-called 'qualified mortgage,' rule in the presidential debate, he touched on one of the thorniest issues in mortgage lending these days.

Many lenders aren't waiting around for regulators to define what a qualified mortgage is and instead are writing their own rules. Most notably, they are being super strict about debt-to-income ratios, which is limiting some borrowers from getting a home loan. Higher credit scores and stricter documentation requirements also are restricting access to credit.

The Consumer Financial Protection Bureau is expected to finalize a rule in January requiring that lenders verify a borrower's ability to repay a loan unless the loan falls under the definition of a "qualified mortgage." The qualified mortgage provision is expected to establish a general set of standards about a borrower's ability to repay a mortgage, including debt ratios and employment status.

Without a clear definition in place now, "the uncertainty on rules and regulations is causing lenders to pull back out of fears of making a mistake," says David H. Stevens, the president and chief executive of the Mortgage Bankers Association, who has been hammering on the issue for months in speeches across the country. "It's causing lenders to keep standards tight because they don't know what risk they're taking until the final rule is complete."

To be sure, banks are making mortgage loans, but the bulk of the activity is for refinancings, not new purchases. Refinancings made up 83% of all mortgage applications for the week ended Oct. 3, according to the MBA.

In the presidential debate Wednesday, Republican candidate Romney cited QM as a reason many borrowers are struggling to qualify for loans. "It's been two years, we don't know what a qualified mortgage is yet. So banks are reluctant to make loans, mortgages," Romney said. "Try getting a mortgage these days."

Debra Still, the president and CEO of Pulte Mortgage, and the MBA's chairman-elect, met with Romney a few weeks ago at a fundraiser in Orange County, Calif., to discuss the QM rule, Stevens said.

Lenders generally are concerned that the rash of regulations including QM will ultimately close the door on a significant number of potential homebuyers.

Banks and mortgage lenders expect the final QM rule may ultimately require that borrowers have at least a 43% debt-to-income ratio.

"It means you're going to be more conservative so if (the final rule) has a 43% debt-to-income ratio, a lender will go with 41% to allow room for underwriter error," says David Zugheri, executive vice president and co-founder of Envoy Mortgage in Houston. "The private market during the credit crunch left a lot of lenders holding the bag so no one wants to take any risk by going outside the box."

"Debt to income ratios don't constitute what is a safe or unsafe mortgage," adds Jim Deitch, the chief executive of TeraVerde Financial, a Lancaster, Pa., bank advisor and asset manager. "QM contemplates saying that if you're above a 41% or 43% debt-to-income ratio, by definition it's not a safe mortgage. Since the industry doesn't want to be cited for non-compliance and they don't want to be sued, they are taking a pass."

Lenders also are concerned that self-employed borrowers, non-W-2 employees that earn bonuses or commissioned salespeople will be unable to cite mitigating factors in calculating their incomes, he says. The general hue-and-cry over the QM rule boils down to what has not yet been defined and how a lender determines a borrower's ability to repay a loan.

While lenders generally are advocating for looser credit standards, they also claim to be trying to balance the need for consumer protection and sustainable loans on the one hand, while on the other hand ensuring access to homeownership for the largest number of people possible.

"Because of QM we've eliminated options for consumers," says Chris George, the president of CMG Mortgage, a San Ramon, Calif. mortgage lender. "The uncertainty associated with Dodd-Frank has kept people on the sidelines and since we haven't written the rules, a lot of people haven't decided if they want to participate in lending at all."

Consumer advocates have argued that originations because lenders are failing to offer borrowers the lowest rates, are charging higher fees and are placing additional restrictions because they simply don't have the capacity to process so many loan applications.

Still, banks and mortgage lenders can hardly cry foul about losing customers because of tighter credit standards. Rock-bottom interest rates have created a nearly year-long refinance boom helping lenders reap massive profits.

Lenders also are benefitting from the government's Home Affordable Refinance Program that allows lenders to refinance underwater borrowers without the risk of repurchasing bad loans.

Mike Hardwick, president of Churchill Mortgage, said he expects a record $1 billion in originations this year, the highest number in its 20-year history.

"The vast majority of mortgage companies are flooded with business right now," says Hardwick. "With a more stringent underwriting process, which includes higher credit and appraisal standards, the process itself has intensified and as a result, many companies are backlogged with business."