What Exactly Is a ‘Safe’ Residential Mortgage?

By Robert Freedman, Senior Editor, REALTOR® Magazine

Some federal banking regulators think a conventional residential mortgage loan isn’t safe unless it comes  with  a minimum 20 percent down payment.

The country’s six banking regulators have been hammering out rules for what’s known as the qualified residential mortgage (QRM), and if they in fact decide that a qualified residential mortgage must include at least 20 percent down, the ability of your customers to get mortgage financing for a home purchase could be  greatly affected—and probably not for the better.

You might be wondering what a qualified residential mortgage is  is and why it’s suddenly become so important to your business.

Its genesis is legislation that passed last year to curb the kind of lending excess that led to the mortgage meltdown  several years ago. The law requires lenders to keep on their books 5 percent of the value of mortgage loans that are packaged into securities for sale to investors. The 5-percent risk-retention  is intended to ensure lenders maintain  skin in the game on the loans they make so  they won’t make loans of dubious quality. One of the criticisms of the private-label securities that were so popular during the housing boom is that lenders were making loans whose quality they knew was poor because the loans would be securitized and sold to investors around the world, effectively making any future  losses caused by the bad loans  someone else’s problem.

During development of the legislation, NAR and other industry groups supported the goal of protecting against these kinds of poor loan writing practices, and they also wanted to ensure safe, affordable conventional mortgage financing remained available to responsible borrowers who took out loan amounts that they could afford. To that end, the legislation included an exemption from that 5-percent risk-retention requirement for conventional conforming mortgages.

The idea was that lenders would maximize the availability of safe, affordable loans if they didn’t have to retain the 5-percent holdback for these loans. Lawmakers thought the exemption made sense, because they recognized that these  conforming loans —that is, the kind of bread-and-butter loans that Fannie Mae and Freddie Mac handle in their regular business—were never part of the mortgage mess. It was the exotic loans—the stated income, negative amortization, and others—that caused the problems.

As it is, the conforming loans made in the last year or so and handled by Fannie Mae  and Freddie Mac  are among the most well-performing loans ever, NAR Chief Economist Lawrence Yun has said.  That’s easy to understand when you consider  how much lenders have tightened their underwriting standards since the downturn, making it hard in many cases for even creditworthy borrowers to get affordable, safe financing.

It’s these safe, conventional loans—i.e., “qualified residential mortgages”— that lawmakers had in mind when they carved out that exemption from the 5-percent risk-retention requirement. But now that regulators are fleshing out the rules for that exemption, they’re talking about requiring these loans to have a minimum 20 percent down. According to a Wall Street Journal article, the Federal Reserve, the FDIC, and the Office of the Comptroller of the Currency are leaning toward requiring 20 percent down. The three other regulators—HUD, the Federal Housing Finance Agency (FHFA), and the Securities and Exchange Commission—haven’t said publicly if they’re leaning that way, too.  The regulators are hoping to release their proposed rules in April.

Considering that conventional mortgage loans, including those with 10 percent or even 5 percent down, were not the loans that posed a problem to the mortgage market and that today continue to perform well, the 20 percent is excessive, critics say.

More importantly from the standpoint of sales, requiring even households with good credit risks to come up with 20 percent down could have a devastating impact on home sales.

The challenge would be especially hard for first-time buyers. According to data from NAR’s 2009 Home Buyer and Seller Profile, more than 75 percent of first-time buyers put down less than 20 percent. Only 13 percent made a down payment of 20 percent or more. Assuming a large percentage of those buyers put down less than 20 percent because they simply couldn’t afford to put down more, despite the fact they’re responsible borrowers taking out loans whose monthly payments they can comfortably afford, then you can see the kind of problem the 20-percent requirement would cause in markets around the country.

Even among repeat buyers, almost 65 percent of them made down payments of less than 20 percent.

NAR made its concerns clear in a letter it sent to banking regulators in January with other industry organizations. “It has been suggested that the QRM standard include a very high down payment requirement in order to limit QRM eligibility to some arbitrarily small percentage of the market,” the letter says.  “Creating an inordinately narrow QRM exemption could cause significant disturbances in the fragile housing market.”

Along with NAR, the Center for Responsible Lending and the Consumer Federation of American were among the dozen signers of the letter.  How regulators define a safe mortgage is of interest to consumer groups, too.

You can learn more in the video above with Ken Trepeta, head of NAR’s Real Estate Services division.

Robert Freedman

Robert Freedman is director of multimedia communications for the NATIONAL ASSOCIATION OF REALTORS®. He can be reached at rfreedman@realtors.org.

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  1. The pendulum swings the other way…..

    Glad to see NAR working on this and keeping us informed.

  2. Robert,
    Great job on reporting the “Safe” residential mortgage. It is interesting that your research shows that the Buyer with more “skin in the game” was, for the most part,
    not a factor in the meltdown.
    I often tell my friends to replace the $30,000 wedding with making a donation to their children’s future. (A Home) Amaazing that many of the young first time home buyer’s hav two hugh car loans and no savings, which kill or greatly reduce their Home buying power.


  4. Robert Freedman

    John, that’s right: 87 percent of first-time buyers in NAR’s 2009 Profile of Home Buyers and Sellers put down less than 20 percent of the purchase price. Thanks for the question.

  5. None of this will stop sub-prime lenders from flooding back if we ever have another boom. The only way to ensure safe lending is to require PMI on every single mortgage regardless of LTV as a condition to the mortgage creating a lien to the property. If the bank wants to lend to someone without insurance then they waive their right to lien the property. This transfers the risk from the banks to companies that are in business to take risk i.e., insurance companies. It guarantees review of every loan by a qualified underwriter, who will verify income, source of funds, credit, etc. The practice of 80/20 loans which eliminated PMI and its associated regulation from the process is what created this mess. The PMI could be raised or lowered based on risk i.e. lower credit means higher insurance cost, large (verifiable) downpayment means lower insurance cost. But like auto insurance — bad drivers pay more but we all pay something — which in the end protects everyone.

  6. Cynthia Murray

    All you have to do is watch HGTV to see that young people today want it all right now. We had to save up to buy our first home and then it did not have to “Have everything”

  7. Bill Saunders

    There are some wonderful comments here… Huge cars, huge weddings, huge tv’s and not a dime in the bank. I too am often amazed at what has become the “norm” when 2 young people, just out of college are looking at “starter homes” that are larger than my parents’ third home… the housing market depends upon affordable mortgages, true… but our economy as a whole depends on jobs and not every job can be in the tech sector or education (or OMG, politics!). When we make nothing in our country anymore, we will have nothing.

  8. Pat Robertson

    The video mentioned an April, 2011 date to go into effect….what happened with that? I have e-mailed NAR and OAR several times with questions and never got an answer.

  9. Nice post. It is interesting to read and it is very useful for the readers to get an information about real estate.. Anyway, thank you for the information. I really appreciated your blog. I will check this out. Thank you and keep it up.

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