The Consumer Financial Protection Bureau’s qualified mortgage rule that goes into effect Friday requires that lenders document a borrower’s ability to repay a loan. But interest-only loans are excluded from being considered ultra-safe “qualified mortgages” because borrowers often face payment shock once they are required to start paying principal, typically after five to seven years of paying just interest.
Bank of America, JPMorgan Chase and Wells Fargo, have all said they will continue to originate and hold interest-only loans on their balance sheets. Such loans to high-net-worth borrowers tend to have very low default rates.
The $65-billion-asset Bank of the West, a unit of France’s BNP Paribas, said this week that it also plans to continue making interest-only loans.
“We are trying as much as possible to serve our customers the way we served them before,” says Paul Wible, a senior vice president and head of national finance at Bank of the West. “An interest-only loan cannot be a qualified loan, but it doesn’t mean you can’t originate it; you just have to prove to yourself that the customer has the ability to repay.”
Even banks that do not originate interest-only loans are considering doing so.
Raj Date, the former deputy director of the Consumer Financial Protection Bureau who now runs the financial advisory and investment firm Fenway Summer, says he is in talks with some lenders to buy interest-only loans that they originate but do not want to hold on their books.
“From a rate-risk point of view it’s a pretty good product for a bank and tends to skew heavily to super prime,” Date says.
Interest-only loans are a small component of the estimated $250 billion market for so-called non-qualified mortgages, which includes fixed and adjustable-rate mortgages to borrowers with debt-to-income levels above 43%. The QM rule set a 43% DTI as a standard requirement.
Banks’ willingness to continue making interest-only loans shows that a market for non-QM mortgages will exist after Jan. 10. When the CFPB first proposed the rule, many industry officials argued that banks would be reluctant to originate any non-QM loans primarily because they would be unable to sell them to investors. There was also concern that originating a non-QM loan could expose lenders to greater legal liability.
But despite the risks, lenders have calculated that certain loans that fall outside of QM are worth making and holding on their balance sheets. While interest-only loans did cause headaches for lenders during the boom years, they are viewed as safe bets now because banks generally only make them to affluent borrowers who can afford downpayments of 30% or higher.
Wells Fargo said it is making interest-only mortgages available to customers who can use it as part of an overall investment strategy but will not look to market it to average borrowers.
“We do not believe the product’s lower initial payments should be used as a way for customers to afford a more expensive home,” says Tom Goyda, a Wells spokesman. “Since the payments on an interest-only loan can rise sharply in the future, when the loan begins amortizing, this approach could cause customers a hardship.”
Wells will only offer interest-only loans to customers who have a have a documented ability to repay the higher, amortizing loan payments and have a minimum of $1 million in assets.
JPMorgan Chase says it will continue to make jumbo interest-only loans to qualified customers on a case-by-case basis. The bank will assess the borrower’s ability to repay but may allow for lower credit scores and down payments for interest-only borrowers who have significant assets, says JPMorgan Chase spokesman Jason Lobo.
Bank of America says it has been consistently conservative in offering interest-only loans, mostly to borrowers with FICO scores of 720 or higher.
Still, there is still some concern that lenders might loosen credit standards in a tough lending environment. The Mortgage Bankers Association expects a 32% drop in mortgage originations this year, and that steep decline could force lenders to loosen underwriting standards in an attempt to capture more customers.
“If you use interest-only loans for people in wealth management or that have fluctuating incomes and significant amount of assets they can deplete to pay off the loan, that’s doable,” says Dan Perl, chairman and CEO of Citadel Servicing, an Irvine, Calif., nonprime originator and servicer. “But if lenders decide this is a product for the average borrower, you have a payment shock issue when the loan starts to amortize, and you’re setting the borrower up for failure if you make it an everyday product for everyday people.”
The CFPB has banned most of the products that caused turmoil for borrowers during the boom years such as pick-a-payment mortgages or those with negative amortization features. But Perl, who was one of the creators of the no-income, no-asset loans (he coined the term “NINA” loans in the early 1990s), says his biggest concern is whether increased competition could force some lenders to eliminate some lending criteria.
“It’s going to be interesting to see how it all plays out,” Perl says.