Enlarge This ImageWASHINGTON — One of the most important pieces of the Dodd-Frank Act is set to start falling into place Tuesday as regulators offer a plan that would establish stringent underwriting standards for most mortgages, provide limited new rules for servicers, and detail how institutions must retain some risk of loans they intend to sell to the secondary market.
The risk retention proposal is likely to draw protests from the banking industry and concern from lawmakers because it is so sweeping and may reshape the entire lending business.
According to a summary of the plan obtained by American Banker, regulators are proposing strict criteria for what loans are exempt from risk retention requirements, including mandating a 20% borrower downpayment, compliance with certain debt-to-income ratios and limits depending on a borrower's credit history. The so-called "qualifying residential mortgage" test is one of the most important pieces of the risk retention plan because many lenders are hoping to make loans exclusively according to those terms.
Under the Dodd-Frank law, lenders are required to hold 5% of the risk of a loan unless it is considered a qualifying mortgage. But lawmakers left it up to the regulators to determine how that risk was structured, what types of securities may be exempt and what was defined as QRM. Following is a guide to the regulators' plan, which is expected to top 300 pages.
Qualifying Residential Mortgages (QRM)
Lawmakers intended certain loans that met "traditional" underwriting standards to be exempt from any risk retention requirements. But regulators have offered a conservative definition that would exclude many mortgages currently made in the market. Regulators acknowledged as much in the summary, saying they want to ensure QRM loans are "very high credit quality."
To meet the definition, a borrower would have to make a 20% downpayment and could not have a 60-day delinquency on any debt obligation within the past two years. Lenders must also ensure that the borrower's mortgage bill should not consume more than 28% of their income, and their total debts could not eat up more than 36% of their pay. A maximum loan-to-value ratio of 80% under a purchase transaction would be required for a home purchase, while a 75% combined LTV would be needed for refinance transactions (or 70% for cash-out refinancings).
Loans deemed QRM could not have certain product features such as negative amortization, interest-only payments, or significant interest rate increases that add risk to mortgage loans.
Regulators said the LTV ratio would be calculated without including mortgage insurance. While they acknowledged that such insurance typically protects investors from losses when borrowers default, they requested further comment to assess whether loans with mortgage insurance would be less likely to default than other mortgages.
Servicing Rules and QRM Options
The proposal would also include a limited set of servicing requirements that could lower the risk on default of residential mortgages as part of its QRM criteria.
For example, an originator of a QRM would be required to incorporate certain requirements regarding servicing policies, like loss mitigation actions and procedures for dealing with second liens when a first one is modified.
Regulators were quick to note that any servicing requirements included in the proposal will not replace ongoing interagency efforts to develop national mortgage servicing standards. According to the summary, the interagency effort is considering a number of factors not included in the QRM, including the quality of customer services provided throughout the life of the mortgage, foreclosure processing, and servicer compensation and payment obligations.
