Proposed rules sparked by the financial industry meltdown of 2008 could have the effect of clamping down credit so hard that lower-income buyers and many others would be shut out of the mortgage market, critics say.
The critics, including an unlikely coalition of mortgage lenders, consumer advocates, housing industry officials and lawmakers, say regulators have gone too far in their effort to prevent a repeat of the reckless and fraudulent lending that brought the nation's economy to its knees.
Opponents argue that the new rules, proposed by a bevy of federal regulators, could have the unintended consequence of restricting the American dream of homeownership to the wealthy, leaving behind many creditworthy buyers and shrinking the pool of home buyers just as the housing market is struggling to regain its footing.
"If this rule goes through as it stands, the demographic of borrowers who get (favorable rates) will be white and wealthy," said David Stevens, chief executive officer of the Mortgage Bankers Association and former commissioner of the Federal Housing Administration. "African-American, Latino and first-time home buyers will be charged higher prices."
Stevens was commenting on 376 pages of proposed rules for "Qualified Residential Mortgages," which would require a 20 percent down payment and limit a borrower's debt payments to no more than about one-third of income.
Critics say the rules would force up the borrowing costs for lower-income and younger borrowers because lenders would charge higher rates for loans that do not qualify for QRM status. They say that could sideline millions of potential first-time buyers who haven't saved the full 20 percent — and hurt the prospects of the 11 million current homeowners who owe more than their home is worth.
The rules are intended to reduce the number of risky loans by requiring that lenders hold onto 5 percent of any loans that do not qualify for QRM standards. Loans that meet the standards could be sold fully into the secondary market, which is normal practice for most mortgage lenders.
It was this lack of "risk retention" that led to the surge of risky lending that has helped trigger millions of foreclosures and sent home prices tumbling, according to Sheila Bair, head of the Federal Deposit Insurance Corp.
"The fact that securitizers did not have skin in the game with these loans, by and large, or meaningful skin in the game, led to a lot of the lax underwriting and abuses that we saw in the mortgage markets," Bair told the House Financial Services Committee last month.
But others say the regulators are swinging the pendulum too far.
"I think everyone in the industry agrees that you've got to have some skin in the game," said Cameron Findley, chief economist at LendingTree.com. "The what question is: How much skin in the game do you want to have? And how do you balance that with the size of the hole so many homeowners are in today?"
The proposed rules are opposed by a long list of groups that don't often align on financial regulation matters, including the Mortgage Bankers Association, the Center for Responsible Lending and the National Community Reinvestment Coalition.
Critics fear the new standards will create a two-tiered mortgage market in which a borrower with enough money to afford the higher down payment would pay less, compared with an equally creditworthy borrower with a smaller savings account. A recent report by J.P. Morgan estimates the gap could amount to as much as 3 percentage points, which could mean the difference between an affordable monthly mortgage payment and continuing to rent.
The new rules also would hit families harder in high-cost markets. Based on current average prices, for example, buyers in the Northeast would have to come up with $53,000 for a 20 percent down payment on a typical existing home, compared with $33,000 for a typical home in the Midwest.
The rules have also focused renewed attention on the fate of government-controlled mortgage entities, including Fannie Mae and Freddie Mac, and the FHA.
The proposed QRM guidelines would not apply to those agencies, which currently back some 90 percent of all new mortgages. That could further complicate the shared goal of Congress and the White House to wind down government-backed mortgage finance and restore the flow of private capital.
"It's going to force FHA to get huge, because all small down payment loans will go to FHA; there won't be any low down payment finance other than them," said Stevens, the former FHA commissioner. "So they'll still be a huge source of funds for all low down payment loans, 100 percent-backed by the government with no private capital competing."
The new rules are being proposed jointly by six federal regulators: the Federal Reserve, the Department of Housing and Urban Development, the FDIC, the Federal Housing Finance Authority, the Office of the Controller of the Currency, and the Securities and Exchange Commission. The regulators all declined to comment on the widespread opposition, saying they were unable to do so while the official rulemaking comment process is still under way.
But in a sign the regulators have heard the protests, the agencies issued a joint statement Tuesday extending the comment period — originally set to end this Friday — until Aug. 1 "to allow interested persons more time to analyze the issues and prepare their comments."
An analysis by the National Community Reinvestment Coalition found little correlation between size of down payment and default rates. Based on a review of 1 million loans written for the most creditworthy borrowers in 2006 and 2007,the default rate ranged from 0.14 percent for those with a 20 percent down payment to 0.26 percent for those who put just 3 percent down.
"It's still a very acceptable level of default," said John Taylor, president of the NCRC, which advocates for access to banking services. "The industry would be very happy with it."
The default rate for all mortgages outstanding was 8.32 percent at the end of the first quarter of 2011, according to the Mortgage Bankers Association.
Another analysis by LendingTree.com found that of mortgage loans written from 1997 through 2009, roughly 80 percent would not have met the QRM standards.
Critics of the new standards argue that the current high default rate was mostly the result of a wave of predatory lending and exotic loans — from artificially low "interest only" payments to "no documentation" loans that relied entirely on a credit score to assess the risk of default.
There's widespread agreement on the need to better assess the risk of default. But opponents of the new standards say they pose an even bigger risk. If too many borrowers are denied mortgages, the already weak housing market would be further crippled by a dearth of new buyers.
"The concern is they decide to rent for the next five years," said Findley. "So they're not buying, and home prices are going to continue to fall."
Falling home prices have already cut deeply into a key segment of the housing market — the "move-up" buyer that includes growing households who have accumulated equity in their first home. Falling home prices have already erased trillions of dollars of home equity, making it harder to come up with a down payment of any size. The proposed 20 percent down requirement could further shrink that pool of buyers, sending house prices falling further.
"If we exacerbate that by having credit restricted, and the private sector is wary about jumping in, and house prices continue to fall, more homeowners are underwater, putting more pressure on bank balance sheets, it really could tip the scales in a way that would be very dangerous," said Christopher Hebert, research director at the Joint Center for Housing Studies at Harvard University.