The Center for Responsible Lending (CRL) and a research institute of the University of North Carolina just released the results of an exacting study on how borrowers would fare under different QRM scenarios and they don’t look good. Let’s hope CRL made its results available to federal regulators and lawmakers so they have a picture of what could happen if regulators proceed with their plan to require a high down payment for loans to fit under the qualified residential mortgage (QRM) definition.
To refresh your memory, the idea behind QRM loans comes from the big Wall Street reform law enacted about two years ago. The law requires lenders to retain 5 percent of the value of the loans they originate for securitization and sale to investors. That’s a requirement that will drive up the cost of financing for borrowers because it forces lenders to put up capital against risk.
But there’s an alternative to this expensive scenario, and that’s QRM loans. If the loans meet these QRM standards, they’re considered safe, so lenders that originate the loans for securitization don’t have to put up 5 percent. That’s good, except that regulators drafted a definition of QRM loans that would require a large down-payment—as high as 20 percent—along with other credit requirements.
The position of NAR as well as some 40 other organizations, including consumer organizations, is that the Wall Street reform law never intended QRM to impose a minimum downpayment requirement; rather, it only sought to ensure that loans are soundly underwritten.
As it is, the Wall Street law includes another provision that in fact does base loan safety on sound loan terms rather than downpayment amount: the qualified mortgage (QM) provision. Among other things, only conventional 30-year fixed and adjustable-rate mortgages can qualify as QM Loans, and lenders have to assess borrowers based on their ability to repay. There’s nothing in the provision that talks about minimum downpayments or other credit reqirements.
Under CRL’s analysis, which is based on about 20,000 loans made between 2000 and 2008, the default rate for loans that meet the QM definition—at a bit under 6 percent– is about half the default rate for all loans made during that period. Almost 6 percent is historically high, but as CRL points out, the period between 2000 and 2008 is not a typical period from a historical persective, since it encompasses the housing market crash and the extremely deep recession that followed on its heels.
But the difference between the two sets of loans shows that the QM standard does what it’s supposed to do: keep defaults at a comparatively reasonable level while still allowing creditworthy borrowers to get financing. This latter point is key, because it’s easy to keep default rates low—if you make standards so tight that only wealthy borrowers with the best credit profile can get financing. What the QM standard shows is you can limit defaults while still keeping financing available.
But as soon as you turn those QM loans into QRM loans and add minimum down payment requirements and other credit restrictions on borrowers, you in fact improve default rates a bit more but at the tremendous cost of pushing most borrowers out of the market. In the CRL data, the default rate on QRM loans with 20-percent down drops something over a percentage point, but to get that modest improvement more than 60 percent of otherwise creditworthy borrowers are pushed out of the market.
The take-away from CRL’s findings is pretty clear: if the federal government wants to curb bad loans without pushing out millions of otherwise creditworthy households from the market, the QM standard seems to do the job just fine. The downpayment and other credit requirements of QRM are unnecessary and harmful.
Lawmakers should look at these findings carefully. Here’s a link to the full study, called Balancing Risk and Access.