In the aftermath of the residential mortgage crisis legislation was introduced to encourage and require lending institutions to to change the way they lend on residential properties.  Within the Dodd-Frank Legislation there is a provision that requires banks to keep 5% of the loans they originate so that they share the burden of the risk. Ideally they will be more careful about evaluating the credit worthiness of borrowers when they have to share the risk of that loan. If the loans conform with QRM guidelines then the Banks do not have to share the risk. Guess which kind of loans Banks will be pushing?

The Mortgage Bankers Association predicts that loans made outside the QRM framework “will be costlier…” J.P. Morgan Chase estimates that the 5-percent risk-retention requirements could increase rates on loans that don’t qualify as QRMs by up to 3 percentage points. In short those that do not have 20% down payments could be penalized up to 3% interest points on their loan.

What is a QRM – Qualified Residential Mortgage is a 20% down payment that is a conforming loan. Who this benefits: This benefits the banks because it forces home owners to have more ‘skin’ in the game and take a larger stake in the ownership of the home. It is intended to reduce the chance that people will walk away from their homes because they have more money to lose.

Who this hurts: This 20% is an unnecessary hurdle for the middle class American who is otherwise very creditworthy, is at low risk of default, and would have purchased using previous mortgage programs requiring less than 20% down.

Why not 20%? Many Americans have the cash but would rather use the money to invest in the stock market, bonds, retirement accounts, or other investment vehicles that are shorter term, and possibly more stable. Money tied up in a down payment is money that can not be accessed until the house sells. Some people also want to keep cash on hand to replace a roof, an A/C unit, or do other home improvements.

How this hurts the real estate market:

1. Existing homeowners who have lost equity because they are selling for less then they purchased for will be hard pressed to save more as they prepare to move up to a larger house. This requirement effectively traps them in their existing home. This ties up homes that are ideal for first time home buyers. It cuts into inventory!
2. Current first time home buyers have to save substantially more money, and this either forces them to rent longer than they want, or purchase a home that is well below the amount they could qualify for if they had 20%. This discourages early home ownership.
3. It takes capital out of the hands of homeowners who otherwise would have used that money to do move-in upgrades like paint, counter tops, new floors and appliances that will help them sell their house when they eventually go to move.
4. The money tied up in their house can’t be used to stimulate the economy by employing contractors or in other ways like: travel, buying a new car, on clothing or electronics. Individuals are not spending so they can save or are taking on more credit card debt once they are homeowners.

What this bill will not fix: This will not fix the foreclosure crisis because increasing down payments will not change a person’s finances if they: get laid off, have a catastrophic illness, have an accident that keeps them out of work, go through a divorce, or any other life event that disrupts their income flow. All this does is take money out of the economy and gives it to the banks to hold. It does not mitigate their lending risk one bit on an individual basis but what it does do is give the banks just a bit more money in advance in the case of a default.

Focus on the Fix: Legislation should focus on making sure that borrowers are creditworthy and have a low chance of default. In addition lenders need incentives to get borrowers into the right programs for their needs. Getting the right borrowers into the right loans will help build a stronger foundation for future lending.

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