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April, 11th 2011

Some thoughts about proposed federal mortgage rules

– Liz Mair

This isn't exactly the topic of the day, but it is important and I have been meaning to write about it, so here goes.  The federal government is proposing new rules affecting mortgages that I suspect could become somewhat controversial:

... the federal government is proposing new mortgage finance rules under which only home buyers who can afford a minimum 20 percent down payment on a conventional loan would get a shot at the best available interest rates and terms.

[...]

But some of the requirements that federal agencies and the Obama administration are proposing in the same plan have gotten much less attention, yet could prove just as troublesome to consumers:

- Strict mandatory debt-to-income limits. Under the proposal, to get the best mortgage rates, you would need to spend no more than 28 percent of your gross monthly income on housing-related expenses, and you couldn’t have total monthly household debt that exceeds 36 percent of your income.

There would be no flexibility to go beyond those ceilings, unlike in today’s marketplace, in which Fannie Mae and Freddie Mac consider debt-to-income ratios along with other factors through their electronic underwriting systems. Freddie Mac, for example, has an overall debt-ratio limit of 45 percent of an applicant’s stable monthly income.

- To refinance your existing mortgage and replace it with one carrying the best available interest rate, you would need no less than a 25 percent equity stake in your house to qualify. If you sought to take out any additional cash through a refinancing, you’d need 30 percent equity. Today’s typical requirements for a conventional refinancing are nowhere near as strict.

- Pristine credit standards. For example, if you were 60 days late on any credit account during the previous 24 months, you would be ineligible for a mortgage at the best available terms.

Big changes, right?  But are they good ones?  Well, yes and no.

Certainly everything that's laid out here represents what I would think fair to characterize as "best practice" type rules that should already be in effect, by virtue of lenders' own actions, procedures and standards.  Want to buy a house and get a good deal on the debt?  Yeah, you should really have to demonstrate that you can afford it, otherwise the bank is taking a big fat risk on lending you the money at a low rate, and they should really jack it up to ensure they've covered off risk that may be associated with lending to you.  Have problems paying your bills?  Again, the lender shouldn't extent credit on the best available terms to you, especially when the principal is likely to be a few hundred thousand dollars.  This is, to be blunt, common sense stuff.

But that's what raises a flag: If it's common sense, why do we need to legislate it via regulation?  Isn't this what should just, you know, happen as a matter of course?  Yes, and I suspect the answer is, it does.  The real issue with the housing crisis was not borrowers who couldn't afford their payments, had a bad credit history, etc., getting the lowest available rates and then defaulting.  The real issue was people who had no business whatsoever taking out mortgages when they shouldn't have, and on bad terms (like, say, with massive great whopping interest rates being involved initially or somewhere down the line), and then defaulting-- oh, and the fact that risk associated with them doing so had been spread very, very widely throughout the system, threatening a systemic failure and thus putting the bank bailout on the table.  Do these proposed rules do anything about that, seems a question worth asking.

Possibly, I think.  Rules like this could certainly codify a common sense rule that should exist that runs along the lines of, if you're a lending risk, you're going to get expensive credit on bad terms or not at all, thus potentially dissuading you or at least covering the lender's backside a little bit better if you are prepared to gamble and take it on.  That is a good thing, though like I say, I'm not convinced it should be a necessary one.  What is necessary is a) people in the financial sector understanding the concept of bubbles-- it's unwise to presume that things can just grow and grow and grow and never burst or shrink, b) people being responsible-- and that would include dodgy mortgage brokers out to make a fast buck, and lenders who actively avoid looking for what could be wrong with a given picture and c) people being willing to tell borrowers who can't afford what they want "no."

It's also a potentially controversial thing, I think, for two big reasons.  First, America loves the idea of home ownership, and this could make it harder for some people to get on the housing ladder-- so the rules feel potentially "un-American," and like they're designed to block opportunity, not extend it.  Second, and following from that point, a lot of the people who will get deprived of the best terms under these rules will be-- surprise!-- minorities and poor people.  Let's set aside that this will annoy liberals who honest-to-God believe that a major cause of the financial crisis was discrimination in mortgages (i.e., preferential enough terms were not given to people where a commercial determination was made that they were a risk, which they subsequently proved to be; if only we'd given NINJA borrowers fixed 4% 30 year mortgages!).  Hard-and-fast locking in of "bad" debt terms for folks who can't obviously afford the debt they seek to take on will upset and frustrate everyone who saw housing policy as a potential great equalizer when, if these rules go through, it will enshrine common sense, which also means that people who many of us want desperately to help will not be helped via cheap, favorable-term mortgages.  As  Michael Calhoun, president of the Center for Responsible Lending, is summarized as saying in the piece, "adopted in its current form, the proposal would make it much tougher for modest-income and minority consumers to ever afford a first home."

The libertarian in me says "don't regulate, the market can deal with this issue without these rules."  The pissed off taxpayer in me who thinks the financial crisis and TARP should never have been on the cards in the first place if people just behaved like adults says, "everyone can live by some rules, since responsible me bailed their asses out."  The truth is, we shouldn't need this regulation, but we do need people to behave more responsibly-- and that includes everyone within the system, potential borrowers and pundits who would have us believe that allowing high-risk borrowers to take out loans designed for low-risk folks based primarily on demographic attributes represents smart policy. [intro]

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