Blacks and Hispanics are likely to find it more difficult to obtain credit or face paying higher prices when the "qualified mortgage" rule goes fully into effect.
While the Consumer Financial Protection Bureau's new rule ostensibly takes effect in January, the agency has temporarily ensured that it will not impact minority borrowers by allowing any government-sponsored loan to be considered a "qualified mortgage." Once that provision expires, which could be extended for up to seven years, many minority borrowers would no longer qualify for QM status.
Roughly one-third of black and Hispanic borrowers would not meet the requirements of a QM loan based solely on its debt-to-income requirements, according to a recent Federal Reserve Board report.
Although it is not a problem immediately, many bankers and consumer groups are concerned about the impact QM will ultimately have for such borrowers. Banks are also worried that they could potentially face fair lending claims if they unintentionally discriminate against minorities by largely sticking to just making QM loans.
"It is a dilemma and there are no good answers," said Leonard Bernstein, a partner and chair of the Financial Services Regulatory Group at Reed Smith. "Banks are going to have to do some self-testing and review their [Home Mortgage Disclosure Act] data if they want to limit their lending to loans meeting the QM test . . . conversely, banks will need to be ready to defend a fair lending claim when loans are made outside of QM because simply saying the price is higher because the risk is higher may not be a defense that prevails."
Industry and consumer groups have long warned about the potential for QM to cut off credit to minority borrowers. But the Fed's HMDA report released last month provided concrete statistics that demonstrated that many minorities have weaker credit profiles that will leave them unable to qualify for a QM loan.
Josh Silver, vice president of research and policy at the National Community Reinvestment Coalition, described the QM standards as "a tough balancing act" in removing irresponsible lending without accidently squeezing affordable housing in the process. His group has urged the CFPB to ease up on the agency's 43% DTI requirement as part of the housing rule.
"We need responsible lending standards and we also need to make sure creditworthy borrowers are not shut out," Silver said. "The 43% DTI needs adjustment if it is shutting out creditworthy borrowers."
In its report, the Fed was careful not to criticize the QM rule, noting other factors that—at least for now—should help keep credit available to low-income and minority borrowers. According to the report, 22% of home-purchase borrowers in 2010, including 33% of blacks and 31% of Hispanics, would not meet the new QM standard based on the 43% debt-to-income requirement.
But the Fed noted that 70% of those borrowers would obtain government-sponsored loans, which are accepted as QM loans for the next seven years or until Fannie Mae and Freddie Mac are restructured, whichever comes first.
"In 2010, lower income borrowers and black and Hispanic-White borrowers were more likely than other groups to have [payment-to-income] ratios above 43%," says the paper, which was prepared by Neil Bhutta and Glenn Canner of the Fed's division of research and statistics. "That said, most home purchase loans in 2010 with PTI ratios above 43% were government backed; under the current regulations, such loans could still be qualified mortgages despite exceeding the threshold."
What's lacking from the report and other market indications is what happens to those 22% of low-to-moderate income and minority borrowers when the seven-year window is up or Congress reforms the GSE.
"It's a real concern," said Karen Shaw Petrou, managing director of Federal Financial Analytics. "It's very difficult to know whether a conservatorship of Fannie and Freddie will keep the low-to-moderate income borrowers in QM or if those loans will go completely private."
In a statement, the CFPB said it included the government-sponsored enterprise exemption in party to ensure that QM addressed "situations where the overlay of the regulations on top of lenders' existing programs might have restricted the availability of affordable, responsible credit."
"The bureau recognizes that these programs and lenders are already subject to specialized underwriting criteria designed to determine whether consumers can afford their mortgage loans," the agency said.
Observers had mixed estimations about QM's long-term impact on affordable housing but many hoped economic conditions would improve within seven years so that there would be a smaller percentage of borrowers who exceeded the new DTI cap.
"The logic is that over this period of time, the housing market will recover, we will resolve the reform of the GSEs and have a whole different situation," said Jo Ann Barefoot, co-chair of Treliant Risk Advisors. "And if it's necessary to take additional steps to protect access to mortgages, that will happen."
In the meantime, borrowers who can't meet the CFPB's QM version will likely end up in the softer QM rules proposed by the Department of Housing and Urban Development which allows borrowers who have higher DTI ratios to still get a Federal Housing Administration loan based on so-called "compensating factors."
Michael Calhoun, president of the Center for Responsible Lending, says such considerations should be further studied by the CFPB as regulators dive deeper into the mortgage data.
"We have all along been clear that we strongly support allowing QM status on loans over 43% providing compensating factors," Calhoun said. His group has estimated "between 15-20% of the mortgage market are loans above the 43% and they perform quite fine. . . . Cleary, DTI is important but it's not like there's a cliff after 43%."
There's still a worry, however, that options would become increasingly expensive for because government-backed loans like FHA tend to be costlier than conventional loans. According to the Fed's report, more than 75% of blacks who purchased a home in 2012 ended up with a nonconventional loan like FHA, the highest percentage of any ethnic group in the study.
"That's astounding and a cause of concern," Silver said. "We don't want a dual lending market in which African-Americans are mostly served by FHA loans because FHA loans are more expensive than conventional loans."
Petrou said that hopefully the culmination of mortgage rules coming out of various agencies will "prevent a monopoly takeover of high loan-to-value lending by FHA and VA."
"But that very much remains to be seen," she added.
Even if the GSEs are dialed back from affordable housing, there's a high probability that the private market would step into the space to pick up some of the riskier non-QM loans—though at a cost. The CFPB's former No. 2, Raj Date, has already started a non-QM venture through his firm, Fenway Summer LLC. Date, who said he was "not surprised" by the Fed's estimates on QM, added that the overall non-QM market will likely run between 15% and 25%.
"If the GSEs pull back, it would by definition create space for private capital to satisfy that unmet demand," said Date, managing partner at Fenway Summer. "Of course, the GSEs have a superior cost of capital to any private market participant, so pricing in the private market would likely be somewhat higher. More significantly, perhaps, private market participants tend to find it much harder to hold and hedge interest rate risk, so that would presumably diminish the availability of the 30-year fixed rate product for higher-DTI loans."