Qualified Residential Mortgage

There have been many reasons advanced for the Housing Crisis. Key among the claims was that Mortgage Lenders made loans to borrowers who had no capability to repay the loan. To resolve the problem, regulatory agencies, through Dodd-Frank, have instituted new guidelines for mortgage under the term Qualified Residential Mortgage (QRM).

Under Dodd-Frank, two classes of mortgages were established, the QRM and the Non-QRM. QRM mortgages met certain guidelines and were considered “safe”, meaning that no additional protections or considerations were needed when lending on such loans. The QRM loan would be GSE saleable, and the lender would be protected from borrower or investor litigation for ability to pay or other defined issues through the “Safe Harbor” provision.

Adding confusion to the issue, the statutes also reference Qualified Mortgages (QM), a subset of the QRM.

The criteria for a QRM loan is similar to the criteria for a QM set forth in the Ability-to-Repay Rule, but there are some significant differences. In particular, the proposed rule defining QRM: 

(a) capped the interest rate increases for adjustable rate mortgages whereas the QM definition merely clarified how the adjustment should be factored into an Ability-to-Repay determination,
(b) contained a maximum loan-to-value ratio of 80% for a purchase money mortgage whereas the QM definition does not establish loan-to-value limits,
(c) required a 20% down payment for a purchase money mortgage whereas the QM definition does not require a specific down payment amount, and
(d) required a debt-to-income ratio of 36% in contrast to the QM limit of 43%.
(e) allows for the GSE’s, FHA and VA to establish their own debt-to-income ratios which could be substantially higher than the 43% limit.

These distinctions would become irrelevant if the QRM Agencies choose to adopt the QM definition as the QRM definition. However, if the six agencies adopt some but not all of QM as the definition of QRM, then mortgage lenders and securitizers may have to consider two underwriting standards to satisfy the ability to repay and credit risk retention rules.

Non-QRM loans do not meet the QRM or QM standards. The loans do not allow for a “safe harbor” provision, and would be subject to borrower or investor litigation. To ensure that mortgage lenders would not “arbitrarily” fund and sell loans to investors or securitizers of loans, where there was greater default risk, additional requirements were established to protect these parties under Dodd-Frank.

For Non QRM loans, mortgage lenders and securitizers of asset-backed securities will be required to retain an economic risk (no less than 5%) in the assets (loans) collateralizing the asset-backed securities. The “retained risk” provides that lenders have some “skin in the game” after they sell the loan. However, if all of the assets collateralizing the securities are QRMs, then the risk retention provisions do not apply.

Combined with the potential borrower and investor litigation possibilities that exist on such loans, it is believed that this will lessen the chances of non-qualified borrowers obtaining loans that they would default on.

 

Challenges of QM and QRM

The CFPB, when it released the new QRM guidelines in 2001, recognized that there would be problems associated with the new guidelines, specifically excluding borrowers who might otherwise qualify for loans except for “deficiencies” in loan level or borrower level characteristics. From their release: 

“Any set of fixed underwriting rules likely will exclude some creditworthy borrowers. For
example, a borrower with substantial liquid assets might be able to sustain an unusually high DTI
ratio above the maximum established for a QRM. As this example indicates, in many cases
sound underwriting practices require judgment about the relative weight of various risk factors
(e.g., the tradeoff between LTV and DTI ratios). These decisions are usually based on complex
statistical default models or lender judgment, which will differ across originators and over time.
However, incorporating all of the tradeoffs that may prudently be made as part of a secured
underwriting process into a regulation would be very difficult without introducing a level of
complexity and cost that could undermine any incentives for sponsors to securitize, and
originators to originate, QRMs.”

What appears to have been missed with the new guidelines is that just as many otherwise qualified borrowers will be excluded from mortgage loans lower income, under qualified borrowers may be included. For example, a 43% debt-to-income ratio on a loan amount of $175,000 for a family of three would find that the borrower would have actual Negative Cash Flow, with an increased risk of default. For the lower income borrower, sound underwriting practices will also be required. (Though these loans would be subject to Safe Harbour provisions, the provisions might be bypassed through the use of Consumer Protection Statutes enacted by different states).

 

The Opportunity

For the portfolio lender or securitizing entity, recognition of the “excluded borrower” holds a significant opportunity to service the needs of this market segment. Though the use of more advanced underwriting analysis, the “excluded borrower” can be properly evaluated to determine the true default risk on a loan. Based upon this type of analysis, loans can safely be approved or denied to match the desired risk level of the investor. 

BDS has the systems and methodologies in place to provide the lender the ability to properly evaluate such loans.