A qualified residential mortgage ≠ a qualified mortgage

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Article Highlights

  • “QRM = QM” clearly does not pass muster under any low risk standard.

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  • A QM was intended in Dodd-Frank to define a minimum loan standard, not to define a low risk loan.

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  • Calling QMs a prime loan and making QM = QRM gives risky loans an imprimatur they do not deserve.

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Today, six federal agencies issued a Proposed Risk Retention Rule calling for a Qualified Residential Mortgage to be equal to a Qualified Mortgage (QRM = QM).  The Consumer Financial Protection Bureau (CFPB) acted in January of this year to define QM.  Defining these two terms is required by the Dodd-Frank Wall Street Reform and Consumer Protection Act.  However, the proposed QRM definition turns the statutory language and the agencies’ earlier analysis upside down.

A QM was intended in Dodd-Frank to define a minimum loan standard, not to define a low risk loan.  Certainly the CFPB’s QM definition demonstrates this–a QM may have no down payment, a 580 FICO credit score (a score in the bottom one-eighth of all scores), and a 50%+ debt-to-income (DTI) ratio (if approved by Fannie, Freddie, or FHA).  A loan with these characteristics is certainly not “prime,” yet the CFPB would call such a loan prime.

A QRM was intended to set a standard for loans placed in a mortgage backed security (MBS) that have a low credit risk as evidenced by their past performance.  In their earlier March 2011 proposed QRM rule, the six agencies defined a QRM as a loan with a “low risk of default even in a stressful economic environments that combine high unemployment with sharp drops in home prices”. They concluded based on substantial and rigorous research that to be a low risk loan, it needed demonstrate three qualities: a substantial down payment of 20% (or low loan-to-value on a refinance loan), a clear demonstration of credit worthiness, and a DTI ratio of less than or equal to 36%.

“QRM = QM” clearly does not pass muster under any low risk standard.

The long-term credit performance of the housing mortgage market can only be as sound as the underwriting practices used to originate a preponderance of loans in that market.  It is axiomatic that a sound market requires that the preponderance of loans be prime or low risk loans.  By caving in to the demands of the lobbies representing the Government Mortgage Complex, both the CFPB and the six agencies are committing a grievous error.  Calling QMs a prime loan and making QM = QRM gives risky loans an imprimatur they do not deserve.  This is a repeat of the false comfort Fannie and Freddie gave to the definition of a prime loan.  As we now know there was little that was prime in most of their prime loans.

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About the Author

 

Edward J.
Pinto
  • American Enterprise Institute (AEI) resident fellow Edward J. Pinto is the codirector of AEI’s International Center on Housing Risk. He is currently researching policy options for rebuilding the US housing finance sector and specializes in the effect of government housing policies on mortgages, foreclosures, and on the availability of affordable housing for working-class families. Pinto writes AEI’s monthly Housing Risk Watch, which has replaced AEI’s FHA Watch. Along with AEI resident scholar Stephen Oliner, Pinto is the creator and developer of the AEI Pinto-Oliner Mortgage Risk, Collateral Risk, and Capital Adequacy Indexes.


    An executive vice president and chief credit officer for Fannie Mae until the late 1980s, Pinto has done groundbreaking research on the role of federal housing policy in the 2008 mortgage and financial crisis. Pinto’s work on the Government Mortgage Complex includes seminal research papers submitted to the Financial Crisis Inquiry Commission: “Government Housing Policies in the Lead-up to the Financial Crisis” and “Triggers of the Financial Crisis.” In December 2012, he completed a study of 2.4 million Federal Housing Administration (FHA)–insured loans and found that FHA policies have resulted in a high proportion of working-class families losing their homes.

    Pinto has a J.D. from Indiana University Maurer School of Law and a B.A. from the University of Illinois at Urbana-Champaign.

  • Phone: 240-423-2848
    Email: edward.pinto@aei.org
  • Assistant Info

    Name: Emily Rapp
    Phone: 202-419-5212
    Email: emily.rapp@aei.org

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