Dennis' Mortgage Blog

The answer to that question will have a major impact on the mortgage and real estate industries in the very near future.

As part of the Dodd-Frank financial reform act, the one that was supposed to benefit consumers, banks and mortgage lenders will have to retain 5% of the balances, or "credit risk", for mortgages that are bundled and sold as securities.  Which is probably 90-95% of the current mortgage market.  On a broad scale, if a lender funds and sells on the secondary market $1 billion in residential mortgages it must retain $50,000,000 in risk on those loans.

The intention of the provision is to require lenders to have "skin in the game" on mortgages, the theory being with this skin in the game lenders will make better credit decisions and therefore fewer loans that go to default.  In practice what will happen is mortgage costs will go up and qualifying will become even more difficult, depending on how the final rules are written.

Exempt from the skin-in-the-game requirement are so called "qualified mortgages."  These would be mortgages that are lower risk and therefore able to be securitized and sent to secondary markets.  To determine the definition of a "qualified mortgage" the Dodd-Frank provision calls for six different regulators from the Fed to HUD to the FDIC to take a stab at defining which types of mortgages may be exempt from the 5% rule.

The six definitions have been submitted and a draft provision is now circulating.  Government agencies by the way are exempt, so any FHA or VA mortgage would automatically be a "qualified mortgage" not subject to the 5% risk retention.  Since Fannie Mae and Freddie Mac are now in a federally controlled trust and backed by the Treasury the question becomes if mortgages sold to Fannie and Freddie are also exempt.  If not look for the agencies to slowly fade away as borrowers find FHA mortgage cheaper to attain, even with mortgage insurance.

Central to the provision is obviously what is a "prime" mortgage?  The common sentiment among regulators seems to be those mortgages with 20% equity in the property.  If this is the final ruling look for housing markets to be severely impacted.  According to CoreLogic Inc, a real estate data firm, only 46% of U.S. homes with a mortgage had twenty percent or greater equity in 2010.

If mortgages with less than 20% equity will require lenders to retain a 5% stake before bundling and selling the mortgages credit underwriting requirements will become a lot stricter, as will insurance of those mortgages.  This will restrict the number of eligible buyers and depress demand and prices.

This provision of Dodd-Frank is a reaction to the housing crisis that was the result underwriting guidelines that were too loose.  Too loose primarily because of federal regulations under the Community Reinvestment Act of 1977 which really kicked into gear in the 2000s when conforming loans with Fannie and Freddie started having sub-prime underwriting standards: debt-to-income ratios to 60% of a borrowers income, stated income, stated asset and no appraisals required on many/most transactions.

With lenders and underwriters tightening their lending criteria to about where it was in the mid-1990s the quality of mortgages funded in the past two to three years are the highest quality in my twenty-five plus year career.  Unfortunately the Dodd-Frank skin-in-the-game requirement ignores the changes made by the industry in reaction to the housing market collapse and subsequent foreclosures and instead puts forth a provision that can lead to another collapse of a housing market that is still in crisis.

Mortgage rates continue to remain low for the time being.  Call or email Dennis today to determine your purchasing power for a new home loan or monthly savings from a refinance.  Direct dial 562-472-1118