Will New Rule Affect Our Ability to Buy Homes?

Maybe you have heard of the Dodd-Frank legislation signed into law last year.  More likely, you haven’t.  The law is aimed at overhauling financial regulations as a response to the subprime mortgage scandal and financial meltdown a few years ago.  Depending on who you talk to, the new regulatory rules being spawned by this law are fantastic for consumers, bad news for consumers, horrible for the financial industry or all of the above.  I don’t want to get into the politics of the law but I do want to mention a rule that has come out of this legislation that could make it difficult for a large number of people to obtain a mortgage and ultimately buy homes.

This proposed rule is a result of a provision in the Dodd-Frank Act that requires lenders to maintain a stake in mortgages sold to investors.  For years lenders to less than perfect borrowers have sold loans to third parties in an effort to reduce their risk and to increase liquidity.  We all know what happened when people started defaulting on those loans over the last few years.  As a result, the intention of part of the Dodd-Frank Act is to encourage lenders to tighten their underwriting guidelines by requiring them to maintain a 5% stake in any loans made to marginal borrowers and then sold to third parties. The theory is that this would reduce the number of loans that default because lenders would still have a vested interest in the success of those loans.  It’s a noble cause to save us from ourselves as so many other laws have attempted to do in the past.  The trouble is, now that no fewer than six regulatory agencies have come together to create a rule to enforce the Act, many are wondering if anyone but perfect borrowers will be able to obtain a mortgage.

The proposed rule defines what loans will qualify for exemption from the 5% risk-retention requirement placed on lenders.  Essentially, it boils down to only loans to borrowers that fall under a new debt to income ratio cap and have a 20% down payment will qualify for the exemption.  What I think is most worrisome is that there appear to be limits on lenders written into this rule that would restrict the number of loans qualifying for the exemption.  Some people are estimating that as many as 66% – 90% of all loans currently being sold to/securitized by Fannie Mae and Freddie Mac would fail the exemption test.

The big fear is that lenders won’t want to write any loans that fall into the 5% risk-retention requirement.  However, if there is money to be made, and there will be, someone will be willing to take the risk.  The question is, what will be the cost of that risk that will be passed on to the borrower?  Will the increase in fees or interest rates be prohibitive?  The good news, for now, is that this rule is just a proposal.  The housing industry is too big a part of our economy to be put at risk by prohibiting people from buying homes.  There is a lot of opposition to this proposed rule and it is coming not only from bankers and bank lobbyists but also from those who have been critics of lending practices.  Will they be able to get regulators to re-evaluate and re-write the rule?  Let’s hope so.



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About Dan Seim

Dan Seim is the primary contributor to Preferred Residential's blog. He has been writing about real estate issues that affect home owners in Bend and Central Oregon since 2011.