Eric Appelbaum of Sterling National Bank continues our conversation. Eric focuses on the definition and impact of the Qualified Mortgage Rule.
We touched on Dodd Frank in our last conversation together, but can you elaborate on the impact, specifically the definition and impact of the Qualified Mortgage Rule?
The Qualified Mortgage Rule (QMR) really creates a safe harbor for the banks. If they issue a qualified mortgage to a qualified buyer, then they cannot be sued by the buyer. This is phenomenal because banks have been sued by buyers and the Attorney Generals for umpteen billions of dollars. So, the rules are very strict and because the CFPB has been regulating banks over the last two years, banks have been scared to issue mortgages that are not qualified. There are two rules with the QMR. The first rule is that qualified mortgages must amortize over a set period of time and cannot have a prepayment penalty. So, qualified mortgages have a 30 year or 20 year or 15 year fixed rate or an ARM, for instance.
Then, you have mortgages such as interest only loans, loans that have more than a 30 year amortization, loans where the rate can adjust over short periods of time, loans with a negative amortization. These loans are not qualified mortgages.
The second rule with the QMR is that the applicant cannot spend more than 43% of their qualifying income on their debt. This is a big deal. This is going to and has already eliminated mortgages for a large portion of Americans. There is a large percentage of Americans that are self-employed, that unfortunately do not declare a lot of their income. They write off a lot of their expenses. Their net income is very low and they do not qualify for a traditional mortgage because they just don’t show the income. However, these people usually have a ton of assets, fantastic credit and have been self-made. They’re very proud. They run their own businesses or consulting firms. These are not defaulters. Before the craziness of 2004 to 2007, banks that did no-income loans usually required more money down, required the person to have a very high credit score, required the applicant to have been in the same field for five years or more and to have a tremendous amount of post-closing liquidity. What I read was that those no-income loans actually performed better than the traditional loans. People who met those guidelines were not defaulters, but Dodd Frank did not want to open Pandora’s Box and allow the no-income borrower to come in. They did not want, in my opinion room, to leave room for interpretation.
Now, that doesn’t mean that banks can’t issue non-QM loans. But, let’s say there is a business owner with a tremendous amount of liquidity and a lot of money in the bank and the bank sees the deposits going in, but for one year, the business owner did not show the income for whatever reason. Under normal guidelines, if you didn’t show any income for the last year and you are self-employed, then you don’t have any income to qualify. Let’s say that the bank has been doing business with this person for ten years and last year was an aberration. The bank can say – You know what? This is a great client of ours. We are going to issue him a mortgage. You are going to see more of that, but now, you are also going to see a lot of people getting denied.
It really is simple. The banks can’t sell certain products. The applicant must meet the debt-to-income ratio of 43%. Plus, there is a rate test that forbids the bank from charging too high a rate.
How does the QMR affect the local, New York City buyer?
A lot of people in New York work for Wall Street, so their compensation comes from bonuses, so they like the interest-only loans (IO) because they can live off of their salary and pay down the loan as time goes on. So, banks are still issuing IO bonds, but there are just fewer of them. And, those who are offering the IO loans are usually doing so at a much higher rate because there is more risk. Nobody knows how it is going to play out. Certain banks say that they don’t care and other banks say they do care and they pulled out of the IO market. My feeling is that banks are going to just increase the rate for the IO market and deal with the risk and mandate that the borrower have more liquidity, more job stability – just tighten the underwriting guidelines on those non-qualified mortgages.
Do you think that the new mortgage rules will affect pricing?
I think that the mortgage rules will not only affect pricing, but also the cost of getting a mortgage. Because so many more rules have to be followed and processors have to check so many more things, these people have to get paid somehow, so costs are rising. It is going to have to get passed onto the consumer and we are seeing that happen already.
In your opinion, what is the tipping point with rates that will force prices to decline?
That is a very good question. Before July of last year, you had 30 year fixed rates at 3.5% and everybody wanted a “3” handle. Now you are in the “4’s” and “4’s” are still good. I still think that “5’s” are good because I have seen 9.5%. I think that once you get over 5.5% and you are closer to 6%, you will see things dry up very quickly. It becomes that much more expensive per thousand to borrow money on a monthly basis. So, $1,000 dollars at 6% happens to cost $6 per thousand per month. But at 4.5%, it’s $5 per month. That is a big difference. This is just a subjective thing, but the tipping point, in my opinion, is that in the upper “5’s” things start to slow down.
Who knows what is going to happen with rates? The FED is starting to pull back. The ten year bond went from 1.5% from 3.75% and now it’s been trading between 2.7% and 3%. If it goes to 3.7%, which it could very quickly, then mortgage rates will go up that one percent.
Another thing that you are seeing is that a lot of big banks are giving away their 30 year fixed rate mortgages for ridiculously low rates. They have to mark those to market at some point and if rates go up one percent, then they are going to lose a lot of money on them. Now, they are making the spread between the deposit and that rate, but as deposit rates go up, it is going to be horrible for them. It’s not like a savings bank that issues five year adjustable loans where they only have interest rate risk for five years. These banks are issuing 30 year deals, so they have risk for 30 years.
