WASHINGTON Federal Reserve Board Gov. Elizabeth Duke expressed concerns Thursday that new mortgage rules released in January could hold back the flow of credit for weaker borrowers in the current "murky" mortgage market.
In a speech to the Housing Policy Executive Council, Duke pointed to the mortgage servicing and "qualified mortgage" rules released by the Consumer Financial Protection Bureau. While she said they were important, she said they may prove costly to lenders.
The mortgage servicing "standards remedy past abuses and provide important protections to borrowers, but also increase the cost of servicing nonperforming loans," said Duke.
Duke said that lenders would be less likely to extend credit to weaker borrowers because servicers typically receive the same fee for processing a current loan as they would get for the more expensive processing of delinquent loans.
"This model especially in conjunction with higher default-servicing costs gives lenders an incentive to avoid originating loans to borrowers who are more likely to default," she said. "A change to servicer compensation models for delinquent loans could alleviate some of these concerns."
Duke also raised fears about the CFPB's rule that requires lenders to ensure borrowers have the ability to repay a loan before extending credit. The rule creates an ultra-safe class of loans known as qualified mortgages with specific debt-to-income and other underwriting criteria.
Duke warned that lenders will face higher costs if they go outside of QM loans. Because QM loans have a safe harbor protection and those outside that designation do not lenders will face an increase in potential foreclosure losses and litigation costs once courts begin to settle ability-to-repay suits, she said.
She also cited higher risks for lenders that try to securitize non-QM loans and said investors might demand a higher premium for mortgages outside the ultra-safe class. The non-QM market may be small and illiquid, at least initially.
Despite potential higher costs, Duke said loans written outside QM "should have very little effect on access to credit in the near term" because most loans currently meet the standards already.
However, Duke contended that there are two aspects of the QM rule that may slow down the development of a larger non-QM market once lenders' risk appetite and private capital increases.
"First, the QM requirement that borrower payments on all debts and some recurring obligations must be 43% or less of borrower income may disproportionately affect less-advantaged borrowers," she said. "Second, the QM definition affects lenders' ability to charge for the risks of originating loans to borrowers who are more likely to default."
Duke noted, however, that the loan originator compensation caps outlined in the rules that may dampen lenders' credit appetite for weaker borrowers "is still unclear."
Also uncertain to Duke was how lenders' fears of having to buy back poorly underwritten loans from the government-sponsored enterprises would affect the credit markets.
"The ability to hold lenders accountable for poorly underwritten loans is a significant protection for taxpayers," she said. "However, if lenders are unsure about the conditions under which they will be required to repurchase loans sold to the GSEs, they may shy away from originating loans to borrowers whose risk profiles indicate a higher likelihood of default."
While Duke focused mostly on the QM and mortgage servicing rules, she declined to comment on the separate Qualified Residential Mortgage rule that has yet to be finalized by prudential bank regulators. Instead, she urged other policy changes such as allowing a higher compensation for servicing delinquent loans.
"New mortgage regulations will provide important protections to borrowers but may also lead to a permanent increase in the cost of originating loans to borrowers with lower credit scores," she said. "It will be difficult to determine the ultimate effect of the regulatory changes until they have all been finally defined and lenders gain familiarity with them."