Buying a new home? Will you need 20 percent down payment?

February 02nd, 2011

It is not unusual for legislation made in Washington to have unintended consequences in Madison, or Tulsa, or Denver. Such is the case with the Dodd-Frank Act that Congress passed in 2010 to regulate the financial industries. Initially, most of the publicity after the Dodd-Frank Act was signed into law was the impact it would have on consumers and their credit card and banking relationships. If you are using mortgage calculators to prepare for purchasing a new home in the future however some parts of the Act may have a serious impact on your new home loan options.

Toxic Assets

In the fall of 2008 the federal government passed the Toxic Asset Relief Program (TARP). The purpose of the program was to supply capital to banks and other financial institutions to prevent them from failing. A stated purpose of TARP was to purchase “toxic assets” from these institutions. TARP followed a meltdown in credit and mortgage markets as a result of a collapse of the subprime mortgage market. The “toxic assets” that were to be purchased were mortgages that were failing, under-collateralized or otherwise a danger to the balance sheet of the banks.

TARP funds were given to the banks, but no toxic assets were transferred to the federal government. Rather, they remained on the banks’ balance sheets. The banks used the funds to show liquidity and offset losses, and to remain open.

The toxic assets were removed from the balance sheets the old-fashioned way, through foreclosure.

“Qualified residential mortgages”

In an attempt to prevent banks being heavily invested in residential mortgages considered high-risk, as defined by members of Congress, the Dodd-Frank Act requires the lenders and investors in mortgage backed securities to have “skin in the game” by retaining 5 percent of the value of “non-qualified residential mortgages” or NQRMs. The term refers to the new definition of a sub-prime mortgage. In order to know what a non-qualified residential mortgage is banks must know what a qualified residential mortgage (QRM) is.

If you are using a prequalification calculator or closing costs calculator to determine your purchasing power for a new mortgage the tolerances and parameters set for the calculators are based upon current underwriting standards for conventional mortgages.

As the Dodd-Frank Act regulations begin to take effect concern in the mortgage industry is how federal regulators will define a “qualified residential mortgage.”

Tighter guidelines, higher down payments

The Mortgage Bankers Association has been holding meetings and discussing how QRMs will be treated by the regulators. With Fannie Mae and Freddie Mac owing several hundred billion dollars to the U.S. Treasury to cover mortgage losses, and the need for billions more in funding through 2011 to remain solvent, congressional committees have been holding hearings on how to restructure Fannie and Freddie and therefore the conventional mortgage market.

If, as the MBA fears, the federal government requires that in order to be a QRM stricter qualifying guidelines must apply such as a minimum 20 percent down payment for purchases, or a minimum 20 percent equity for refinances, then the conventional mortgage market may disappear–which, for many in Washington, would not be a bad thing.

Liquidity issue for banks

If higher equity requirements and stricter standards are required for mortgages to qualify as QRMs, and these requirements reduce the number of mortgages a lender has on its books that qualify, it means that more of its mortgages will be NQRMs and subject to the lender retaining a five-percent risk holding in the majority of its mortgages. This creates a severe liquidity issue for the banks.

As a result of such regulation, more borrowers will be forced into either higher-priced private mortgages or federally insured FHA mortgages. Eventually the result will be the elimination of Fannie Mae and Freddie Mac as secondary mortgage markets and the federal government will have more control over the residential mortgage markets–which again, for many in Washington, would not be a bad thing.

If you have been using mortgage calculators and considering purchasing a new home in the coming year, follow the news on the Dodd-Frank Act and regulations it will impose on the mortgage industry as it may very well change your ability to qualify for a new home loan.

Posted By :
Dennis C. Smith is co-owner and broker of record for Stratis Financial in southern California. He has over twenty years' experience in the mortgage industry.

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