If the years leading up to the U.S. housing bust were rife with lax underwriting, the opposite problem has occurred in its aftermath: Excessively tight credit is making it impossible for many borrowers to obtain mortgages.
Enter the Consumer Financial Protection Bureau, which this week unveiled a much-awaited rule intended to strengthen mortgage standards and provide more legal protection to lenders. In requiring that lenders verify the ability of borrowers to repay their loans, the CFPB aims to safeguard consumers against deceptive practices and provide legal protection to banks, which have been wary of lending, fearful that borrowers would eventually default and sue.
The CFPB’s qualified-mortgage rule, which goes into effect next year and was required under the 2010 Dodd-Frank Act, gets many things right: It requires lenders to consider specific factors in determining whether a borrower can repay a loan, including income, overall debt, employment status and credit history. Borrowers’ total debt payments — including car loans, school loans and mortgages — can’t exceed 43 percent of their pretax income.
The rule prohibits many of the exotic loan features, such as interest-only payments, that fed the housing bubble. It also smartly avoids being overly prescriptive. It doesn’t, for example, require a certain level of down payment, which could wind up denying credit to otherwise-qualified borrowers.
Yet the CFPB’s rule alone won’t open the lending spigot. Other pieces must fall into place, including finalizing — and harmonizing — a rule detailing which types of mortgages will be exempt from a requirement that lenders retain a 5 percent financial stake in loans that are packaged into securities and sold.
Capital levels for banks must also be firmed up so companies can determine how much they can safely lend. Most important, the U.S. government must outline its plans for Fannie Mae and Freddie Mac, which own or guarantee about 84 percent of mortgages, including whether the U.S. will continue to offer a mortgage guarantee at all.
The latter question is crucial given the CFPB’s new rule, which will probably lead to fewer types of loans and a heavier reliance on the 30-year fixed-rate mortgage. That product, largely unique to the United States, has traditionally come with a government guarantee.
The CFPB’s rule, intended to set the industry standard for mortgages, gives huge deference to Fannie Mae and Freddie Mac. For example, it grants legal protection to loans that don’t meet the 43 percent debt-to-income test if they satisfy the underwriting standards of Fannie Mae, Freddie Mac and the Federal Housing Administration. The CFPB said this bypass, which could last as long as seven years, was necessary given the “fragile state of the mortgage market.”
As we’ve said, the time has come for a serious overhaul of housing finance, including limiting the government guarantee and adequately pricing it to reflect risk. Fannie Mae and Freddie Mac are profitable again and have stopped drawing on the Treasury. Housing prices are rising and foreclosures are beginning to stabilize.
If the roles of Fannie and Freddie aren’t soon clarified, the companies could become permanent wards of the state. Even Fannie Mae’s chief executive officer, Timothy Mayopoulos, said at a Bloomberg Government breakfast that the company’s mortgage dominance has reached an unhealthy and unsustainable level.
To bring back private capital, lenders need to know what constitutes a qualified residential mortgage and is thus free from risk-retention requirements, also known as the “skin in the game” rule. The rule, which six federal agencies are writing, is supposed to largely mirror the CFPB’s, yet a proposal last year differed in many ways, including imposing a 20 percent down-payment requirement.
The Federal Reserve and other agencies have rightly waited to finalize their rule until the CFPB completed its work, and they should now move quickly to synchronize.
Consumers deserve access to quality mortgages they can afford. The U.S. economy still suffers from the consequences of lax underwriting standards, yet the pendulum has swung too far the other way.
The CFPB’s rules strike the right balance between responsible lending and mortgage availability. Yet truly strengthening the housing market will require more effort by regulators and lawmakers.