-If you own a home, you are screwed. Values are not going to recover anytime soon.
-If you are trying to sell a home, you are screwed. The number of qualified buyers and the availability of mortgage money are going to fall.
-If you are trying to buy a home, you are screwed. To get a mortgage you can afford is going to get harder to find in the near future.
Part of the Dodd Frank FinReg Bill was to require mortgage originators/syndicates to retain 5% of the risk. This is the “skin in the game” concept. It makes perfect sense. It is designed to minimize the amount of stinky mortgages that can be originated. It’s hard to argue with the intent of this rule. But there will be consequences.
Dodd-Frank defined what a good mortgage should look like. They call it Qualified Residential Mortgage (“QRM”). There are stiff hurdles to this definition. EVERY other mortgage (None-QRM) are subject to the risk retention rules. QRM loans are not subject to the new rules.
So what constitutes a QRM? Like I said, its stiff:
*Minimum 20% down.
*Mortgage Insurance can’t be used to make up for the shortfall of real equity by the buyer.
*Owner occupied only.
*Mortgage debt service to income no greater than 28%.
*No prior defaults, judgments or BKs need apply. You have to have a long-term clean financial record.
*Only straight 30-year mortgages meet the QRM definition. No balloon payments, no interest only, no negative amortization.
In my opinion, if these standards were in existence starting around 2000 we would never have had the blowup in real estate that nearly killed us. There would have been no funny money mortgages. There would not have been the insane run-up in prices. Therefore the proposed new rules would significantly reduce the risk of another blowout in mortgage land. But talk about taking the punchbowl away. How many legitimate (qualified) buyers are left standing when the new rules are applied? The answer is very few.
This chart shows the percentage of loans that were originated in the past that met the new standards of QRM.
Note in this chart that the average number of loans that met the QRM standards from 1997-2003 was only 20%. When you look at the number for 2007 (11%!!) you understand why we had a crisis. Fully 89% of all mortgage written were, well, junk. For me, the most significant number is the 35% for 2009. There was a substantial tightening of mortgage standards, but the amount of “bad” versus “good” was still 2 to 1. As the new retention rules take hold the availability of Non QRM will dry up.
What are the prospects for a potential buyer to get a Non QRM loan? In my opinion it will be slim. If it's available at all, it will be expensive. Mr. Lawler points to the fact that Jumbo mortgages (loans that are too large for Fannie or Freddie to purchase) are today available at a cost of about 60 basis points over Non Jumbos. But Jumbos are high quality loans. There is significant equity and stable borrowers behind them. Therefore the pricing for a Non QRM that is smaller than a Jumbo has to be greater than the Jumbo by a significant margin.
If the cost of a new QRM is X% then the Non-QRM pricing will be at least 100bp over QRM levels. This suggests that Non-QRM will have a yield 150 – 200 over ten-year treasuries. I will leave it to the reader to plug in an estimate for the 10-year over time. Today it is only 4.4%, meaning that mortgage costs for the vast majority of borrowers would be 6.4%. Get the 10-year to a more reasonable 5% and mortgages will cost 7% for the average borrower.
Does it matter if the borrowing cost for 60-70% of all potential buyers is 1% higher? Is that a big deal? You bet it is. Does this mean that residential real estate has to collapse? No, but you would also have to conclude that there is very little upside to home ownership. There goes the American dream.
Note:
Dodd-Frank defines QRM and also Non QRM. It also establishes “None Qualified”. These are true junk mortgages. No Docs, Liars, No equity etc. These types of loans would not be eligible for syndication or Agency purchase, period. This, of course, would be a very good thing. There should be no tolerance for these types of loans. Right? Well this chart shows just how many loans would have been deemed Non-Qualified (junk) from 1997 through 2009. This chart staggers me. In 2006 38% of all mortgages were just junk. What were those lenders thinking of? Greed comes to mind.
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Nice charts!
ReplyDeleteThe barn door has been firmly closed on the escaped horse.
Houses prices are deemed too high, but every homeowner will balk at selling for a lower price. It will take a long time for this adjustment to pass through the economic digestive tract
His comment of, "there is very little upside to home ownership."
ReplyDeleteHaving a backyard, not listening to your neighbors argue, block parties, my own back porch with a Weber grill, ......."
Not everything is financial.
Another problem was consumers ONLY using their house for an investment.
wrschindler, you can get all those things by renting a house as I do.
ReplyDeleteJimMtnViewCa-
ReplyDeleteI'm a homeowner, and I won't balk at all at selling for a much lower price than my house was appraised at during the bubble. That is because I bought before the bubble, at a price I could afford, and did not pull money out based on the inflated prices during the bubble.
These principles seem designed to finally pop the housing bubble. As such, I can't believe they will actually be applied; nothing leads me to believe that the financial system, or the government it controls, is any more willing to let housing prices return to realistic levels now than they have been for the last few years.
After reading the article, I also skimmed the actual testimony before the House Sub-Committee, and noticed that these changes will likely take effect a year from this summer. I am hoping to sell my home this summer. My home is typical 3 bed, 2 bath, very much reflective of a median home in our area. Our area weathered the real estate pullback as well as any other (Des Moines, Iowa). Given the upcoming changes to lending required by the Dodd-Frank bill, would you say that if I have to sell my home in the next 3 years, the time to do so is now? While I expect to walk away with less than I put down after Realtor commission, fees, and closing costs, we will have plenty of cash-in-hand even if we sell for less than we paid in 2008(we put 20% down @ 5.125% over 3 years ago). Sounds like the changes (and market forces) may bring prices down further, making it wise to rent for at least the next few years provided we get out of our current home in relatively good shape.
ReplyDeleteAny thoughts/comments regarding the benefits/risks of selling now and renting vs. staying put would be greatly appreciated.
Chas. I'm not qualified to answer your question. I know nothing of your part of the country. RE in some parts of the country will do better than others.
ReplyDeleteI said in the piece that I did not see the changes in mortgage rules as a reason for a (another) collapse in RE. I said there was no upside.
From the little you describe you are/will be one of those who will be able to qualify as QRM borrower. Good for you. Keep that up and you will do fine if RE goes up or down. What you lose on the one hand, you will gain on the other.