Underwriting standards need to be tight enough to ensure the borrower’s ability to repay is feasible within their documented means, yet flexible enough to offer more opportunities for homeownership. However, the trend coming from Washington is to err on the side of caution possibly resulting in standards that are too rigid. Treasury Secretary Jacob Lew told the Senate Banking Committee on Tuesday, May 21, that while most underwriting standards remain conservative in many markets, certain real estate investment trusts are an example of loosening standards that he feels could threaten the market.
It’s a known fact that credit-worthy borrowers are being turned away by local lenders because uncertainty surrounding regulatory standards has left underwriting criteria at the tightest level in decades. The fear is that if only a modest amount of loans are originated to those with only the very best credit, fewer buyers will purchase homes; resulting in a further delay of the housing market’s recovery.
QM AmendmentsHow Will it Refine Underwriting Criteria?
A key regulation lenders have been watching is the upcoming QM/Ability-to-Repay rule. The goal of the QM/Ability-to-Repay rule amendment is to implement certain underwriting standards to ensure loans are being produced that consumers have the ability to repay. However, the QM rule will not limit lenders from only issuing QM loans, but lenders who choose to lend outside of the QM/Ability-to-Repay mandates face fewer legal protections and may have to retain a portion of the loan to protect against default.
The QM rule requires loans to be underwritten based upon the highest monthly payment that will occur within the first five years of the loan’s life. However, the foundation of the QM rule will require that a consumer’s monthly debt payments, including the mortgage, will not exceed more than 43 percent of their monthly income.
The underwriting standards would also include a consumer’s employment and income records, business credit reports and the treatment of Social Security and rental income. While these amendments are intended to ensure lenders are writing loans that safeguard the borrower, by requiring such strict employment histories, consumers with inconsistent income or a history of recent job changes can encounter roadblocks on the way to the closing table.
Loans that fall outside the boundaries of a qualified mortgage will be subject to fewer protections from lawsuits due to default. The risk management and possibility of default with originating a loan outside of QM standards will continue to cause concern among lenders, creditors and investors until the underwriting standards and stipulations “outside of the QM box” are defined.
The amended rule includes a temporary category of qualified mortgages, one that would have more flexible underwriting standards, as long as it complies with the overarching QM features no negative amortization, no interest-only, no balloon payments and meets points and fees cap and also satisfies the underwriting requirements of Fannie Mae and Freddie Mac. However, two separate underwriting standards the GSEs being even more prohibitive, due to their government conservatorship status will invoke stricter credit limitations and borrower qualifications.
Working Outside the QM Box
The underwriting standards leading up to the financial meltdown were far too lax; complicating risk mitigation strategies and eventually leading to the mortgage market’s demise. However, we now currently find ourselves with too strict of underwriting standards; barring would-be potential borrowers from obtaining a loan due to overly restrictive underwriting standards and lenders not wanting to repeat the past.
For the most part, the standards outlined by QM/Ability-to-Repay are sound lending requirements and should provide a level of certainty for lenders to make loans knowing they are compliant.
But are these guidelines still too severe? The mortgage market changed, thus altering the way borrowers manage their money. As the industry transforms and transitions into the post-meltdown era, should underwriting standards change too? Enabling more would-be borrowers with the chance to purchase a home can fuel the economy without causing another housing bubble.
Lenders will have to carefully look at their risk analysis and work with borrowers who fall outside QM/Ability-to-Repay guidelines to determine their credit-worthiness. Mortgages that are accurately structured, with borrowers who have been appropriately vetted and evaluated, can become a profitable line of business and provide more opportunities for homeownership.
Scott K. Stucky is chief operating officer of DocuTech Corp., a provider of mortgage loan documents, compliance services and technology solutions for the mortgage industry.
