May 2011

A Shift in Risk Retention or a Further Shift Down for Real Estate?


Anyone have any thoughts on the 20% down payment rule?  Are things not bad enough?  Historically low interest rates and a 30% cut in housing prices have not created much of a buying season this spring as expected.  Foreclosures, short sales and the incredible oversupply of new homes still sitting on the market coupled with a extremely weak unemployment number all are keeping the housing market from showing any sign of true recovery.  Yet regulators want to make the process more difficult?  The recently proposed risk retention rule a further reform stemming from Dodd-Frank would make it very difficult for the majority of potential home buyers to obtain a mortgage.

The 20% rule still has some hoops to jump through to become implemented but the implications are scary.

To break it down simply:

The risk retention Rule would force banks to keep at least 5% of a loan’s risk on the balance sheet before securitizing and selling the rest of the loan.  Such capital reserves would be for all loans but the safest mortgages, otherwise referred to as “qualified residential mortgages” or QRMs.  In order for a loan to qualify as a QRM there must be a 20% down payment and the borrower must have never had a 60 day delinquency in their credit history.  I should note that FHA Loans would be exempt from the 5% retention Rule.

So when a bank wants to provide a non qualified loan what will the results be?  My guess is higher rates, higher fees and more red tape.  Or perhaps a lender may stay away from non-QRM’s completely?  (If you think you had it bad applying for a mortgage in 2010 or the start of this year, wait until this regulation gets implemented)

I agree that such a rule would undoubtedly limit banking institutions from making poor decisions.  And of course this is its underlying purpose.  But the housing market will surely feel the squeeze and the impact of yet another regulation.  As a point of reference presently less than half of homeowners with mortgages have enough home equity to even qualify to refinance into a “qualified residential mortgage”.

I think legislators have under estimated some of the potential consequences.

What if many small community banks decide to not provide non-QRM loans?  What is the ramification?  Decreasing the potential pool of eligible buyers would only intensify the housing markets problems, creating further declines which inevitably could lead to more foreclosures.

It would be one thing if FHA was a viable alternative.  However, the condition of the federally backed mortgage programs are not enviable and the programs certainly did not intend to insure as much debt as they have over the last 24 months.

I would be 100% fine with the rule if the government more carefully mapped out a way to deal with the potential results.

  • A way to encourage lending to non-QRM borrowers, so banks don’t just shut off the middle class.
  • And some type of risk premium cap on the loans that are given via a non-QRM

Or how about we enact this rule but lower the necessary percentage down?  Interestingly enough the increase in defaults via percentage of down payment are not that extreme.

Moving from 5 to 10% down on a home that already met all other QRM standards reduces defaults by an average of .3%, but eliminates 7-15% of borrowers from qualifying for a QRM loan.

Moving to 20 % down on a home that already met all other QRM standards reduces defaults by an average of about .8%, but eliminates 20-25% of borrowers out of QRM eligibility.

This nation’s economy will never fully recover with out at least a stable housing market.  It is hard to conceive such a recovery with a pointlessly high down payment requirement.