A New Lending Strategy: Mortgages That Are Too Big to Fail

A New Lending Strategy: Mortgages That Are Too Big to Fail
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Representative Jeb Hensarling (R-TX), the primary sponsor of the House Financial CHOICE Act, does not mince words when it comes to the 2010 Dodd-Frank Act.  

Last year, in a scathing speech at the Economic Club of New York, Hensarling said of the law: “Dodd-Frank rests upon faulty principle, faulty premise and faulty policy. [...] When fully phased in, one-third of black and Hispanic mortgage borrowers will be hurt by Dodd-Frank’s Qualified Mortgage rule based solely on its rigid debt-to-income ratio. Ladies and gentlemen, only Washington would dare call this ‘consumer protection.’”

Echoing this sentiment, last summer, The Wall Street Journal published a series of articles warning of related dangers to black and Hispanic mortgage seekers.

According to the Journal, after the financial crisis and the regulatory backlash, banks shifted their strategy from lending to subprime borrowers to issuing jumbo loans to “super-prime” borrowers.

Jumbo loans are mortgages that fall above the loan limit set forth by government-sponsored enterprises (GSEs) such as Fannie Mae and Freddie Mac to determine their eligibility for government backing. For example, if a mortgage is within the limit and “backed” by a GSE, banks are protected (or insured) against the possibility that the borrower defaults on their loan. Until this year, the loan limit was $417,000 for most areas (and more for high-cost markets).

As the super-prime candidates tend to be white and affluent, the WSJ analysis showed that some banks focusing on jumbo loans were lending to hispanic and black populations less frequently overall. Banks were also easing the income requirements for jumbo loans: as the number of jumbo loans continued to grow, the median income for a jumbo loan borrower dropped from its 2007 level.

Combined

Another surprising turn, according to an Inside Mortgage Finance analysis reported in the Journal, is that banks no longer make up the largest portion of mortgage lenders. As of last November, non-bank lenders such as Quicken Loans or PennyMac Financial Services are extending over 50% of loan dollars. Banks, which as recently as 2011 represented half of those dollars, dropped to a mere fifth. Increasingly, they are allocating many more of those loan dollars to jumbo loans. The trend is in keeping with the growing proportion of jumbo loans overall (which, may also be related to rising home prices).

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According to Hensarling and other critics of Dodd-Frank, banks have become less willing to risk lawsuits related to government-backed loans. As banks move away from loans available for purchase by GSEs, a relatively new regulation called the Ability-to-Repay and Qualified Mortgage Rule has allegedly made it harder for some to get loans.

According to a June 2017 report by the Treasury, the new rule — put in place by the Consumer Financial Protection Bureau (CFPB) in 2014 — has placed additional stipulations (such as a 43% debt-to-income ratio) on mortgages that are available for GSE purchase. Lenders, as a reaction, have become less willing to make loans that do not meet the additional standards. As such, between the bank-financed jumbo loans and the GSE-backed non-bank loans, some potential homeowners could fall through the cracks.

The report alleges that reluctance, among with several other factors, has made credit less available. The analysis is supported by the research of the Urban Institute, an organization specializing in economic and social policy research.

Amidst these complex interactions of policies and stakeholders is another critical consideration: there have been far few loan applications in 2015 than in 2007, just before the financial crisis — in fact, almost half as many. Because approval rates for loans have been increasing in aggregate, it is difficult to say whether the regulations are having a disproportionate impact simply because fewer people are applying for loans.

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It’s not clear exactly why people are not applying for as many mortgages. Home prices have generally been increasing — and though credit availability has been low, so have interest rates.

The lack of access to mortgages is not a trivial matter. Traditionally, homeownership has been one of the primary ways for American families to build wealth across generations, and it is one of the reasons why racial redlining practices have had such a lasting impact on African-American families.

If the past is any indicator, lending regulations will have an impact on communities for generations to come.  



Explore mortgage loan data on Enigma Public.