The proposed down payment standards
for new mortgages might push 60 percent of potential borrowers into high-cost
loans or out of the housing market altogether according to a paper released
today by the Center for Responsible Lending. The paper,
Balancing Risk and Access: Underwriting
Standards for Qualified Residential Mortgages, is the result of a study to
weigh the effects of proposed underwriting guidelines for qualified residential
mortgages (QRM), mortgages that are exempt from the risk retention requirements
laid out in the Dodd-Frank Wall Street Reform Act.
The Center, a nonprofit, nonpartisan
research and policy organization with a stated mission of “protecting
homeownership and family wealth by working to eliminate abusive financial
practices” has, along with other consumer and industry groups, raised concerns
about a potential disproportionate impact of restrictive QRM guidelines on
low-income, low-wealth, minority and other households traditionally underserved
by the mainstream mortgage market. The
study examines the way different QRM guidelines may affect access to mortgage
credit and loan performance and estimates the additional impacts on defaults
resulting from guidelines above and beyond QM product requirements.
The researchers, Roberto G. Quercia,
University of North Carolina Center for Community Capital, Lei Ding, Wayne
State University, and Carolina Reid, Center for Responsible Lending used
datasets from Lender Processing Services (collected from servicers) and
Blackbox (data from loans in private label securities collected from investor
pools.) They identified from among 19
million loans originated between 2000 and 2008 the 10.9 million that would meet
the current QRM guidelines, i.e. loans with full documentation that have no
negative amortization, interest only, balloon, or prepayment penalties. Adjustable rate mortgages must have fixed
terms of at least five years and no loans over 30 years duration.
The default rate for the universe of
loans was 11 percent, for prime conventional loans, 7.7 percent, and for loans
(regardless of type) that would have met the QM product feature limits, 5.8
percent. In other words, the research “suggests
that the QM loan term restrictions on their own would curtail the risky lending
that occurred during the subprime boom and lead to substantially lower
foreclosure rates without overly restricting access to credit.”
The next step was to apply some of
the suggested additional criteria for QRM to the loans; a minimum down payment
of 20 percent, a range of higher FICO scores, and lower debt to income (DTI)
ratios. The goal was to determine the
benefit of each as measured by an improvement in default rates without an undo reduction
in borrowers able to qualify for an affordable loan.
When various permutations of
loan-to-value (LTV), FICO scores, and DTI ratios were applied to the loans lower
default rates were achieved. These
improvements, however, were accompanied by the exclusion of a larger share of
loans. As Figure 4 shows, some of the restrictions
resulted in the exclusion of as many as 70 percent of loans.
To quantify this, the authors
developed two additional measures. The
first, a benefit ratio, compares the percent reduction in the number of
defaults to the percent reduction in the number of borrowers who would have
access to QRM loans with the proposed guidelines. For example, an underwriting restriction that
resulted in a 50 percent reduction in foreclosures while excluding only 10
percent of borrowers would have a higher benefit ratio than one with the same
reduction in foreclosures that excluded 20 percent of borrowers.
One finding was that LTVs of 80 or
90 percent resulted in particularly poor outcomes while an LTV of 97 percent
had added benefits of reduced defaults relative to borrower access. This suggests that even a very modest down payment
may play an important role in protecting against default while excluding a
smaller share of borrowers than would a higher down payment requirement.
Since underwriting is unlikely to
impose restrictions in isolation, the study analyzed a combination of possible
QRM restrictions. They found that the
strictest guidelines produced the worst outcomes and that none of the patterns
of proposed restrictions performed as well as the QM restrictions on their own.
The second measure, an exclusion
ratio, looks at the number of performing loans a certain threshold would
exclude to prevent one default. In this
measure, the number of excluded loans can be viewed as a proxy for the number
of “creditworthy” borrowers who would be excluded from the QRM market.
Imposing 80 percent LTV requirements
on the universe of QM loans would exclude 10 loans from the QRM market to
prevent one additional default. Adding
to this a FICO above 690 and 30 percent DTI ratio would exclude 12 creditworthy
borrowers to prevent one default.
The current QRM criteria are more
restrictive for rate-term and cash-out refinancing than for purchase
loans. The study found that the QM
product restrictions are the most effective in balancing the demand between reducing
defaults and ensuring access to credit.
The study also found that imposing
additional LTV, DTI, and FICO underwriting requirements on QM loans had
disproportionate effects on low-income borrowers and borrowers of color. Just over 75 percent of African-American
borrowers and 70 percent of Latino borrowers would not qualify for a 20 percent
down QRM mortgage and significant racial and ethnic disparities are evident for
FICO requirements as well. At FICO
scores above 690, 42 percent of African-Americans and 32 percent of Latino
borrowers would be excluded against 22 percent of white and 25 percent of Asian
households. At the most restrictive
combined thresholds (80 percent LTV, FICO above 690, DTI of 30 percent) approximately
85 percent of creditworthy borrowers would not qualify with African American
and Latino disqualifications each above 90 percent.
The Center says in conclusion that
its research provides “compelling evidence that the QM product loan guidelines
on their own would curtail the risky lending that occurred during the subprime
boom and lead to substantially lower foreclosure rates, while not overly
restricting access to credit.”