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.

Eric Appelbaum is a Division Senior Vice President at Sterling National Bank. Prior to joining Sterling, Eric was the President of Apple Mortgage, a mortgage broker firm, which he founded in 1994. 

So, you were a mortgage broker until you recently joined Sterling. Why did you decide to make the move and what does that indicate about where you see the industry moving?
Great question. That question brings up a lot of issues going on in the marketplace. So, Dodd Frank is all about any party in a consumer transaction having deep pockets to deal with any liabilities. Dodd Frank has basically stated that they don’t want entities or originators without any skin in the game to be handling a large transaction for a consumer, i.e. a mortgage. So, for years, mortgage brokers, who are considered third party originators, would originate through just about every bank that existed. Before Dodd Frank, a good mortgage broker could deal with 40 institutions and have every product available to be competitive. Mortgage brokers originated about 70% of all mortgages. Remember, the mortgage broker would originate the loan, process the loan, send the loan to the bank and the bank would decide if it was worthy enough to pass their muster and would approve or deny it. It worked well. But after Dodd Frank, banks believed that they would be held liable for loans originated through mortgage brokers or third party originators. So, Citi, Wells, Chase, HSBC, Bank of America and a whole host of other lenders pulled out of the TPO market, the third party originator market. For the last two years, mortgage brokers, like myself, were dealing with other players that were able to provide those products, but that market has started to shrink even further. So, I knew that the mortgage broker market was dying a slow death.

The next option would be to become a mortgage banker. Now, as a mortgage banker, the banker originates the loan, closes the loan with a line of credit from a bank and then they sell the loan a few days thereafter to one of those parties. Most banks are dealing with mortgage bankers, which is called the correspondent channel, because bankers have to have some money in the game and have some money set aside. The problem is that the writing is on the wall with Dodd Frank. Regulators and banks want mortgage bankers to have a tremendous amount of liquidity just sitting in their company. But, if you are running a small regional mortgage banker, you’re not going to want to have $5 million dollars sitting in your entity just doing nothing.

So, I needed the platform that would enable me to put loans in a bank’s portfolio, especially a bank that knows this market, close loans and sell those loans, and broker loans. That is what the Sterling model is. They give us the opportunity to give the client the best that we have, and if the best thing is to broker the loan, then we broker it. If the best thing is to bank the loan, then we bank it. If the best thing is to portfolio the loan, then we portfolio it.

So where is the industry going? You are going to have fewer providers, and if you have fewer providers, it is harder to get credit. It is harder to get credit? It is harder to close loans. It is harder to close loans? Then prices go down. A Case-Shiller report that just came out showed that home prices overall have decreased slightly over the last two to three months. What has happened over the last two to three months? The implementation of QM, which we can get into later.

At what point in the buying process should a buyer contact a bank to determine how much he or she can borrow?
The second that they want to start looking for property, they should have their qualifications vetted. You don’t want to get down the road and say I want this, you make a bid, it gets accepted, you hire a lawyer, they send out contracts and then the buyer finds out that they cannot get approved. I still see that. It is not just going to any bank. A lot of these people sitting at the large commercial banks are really not vetting the file. So, we get this all the time. Someone calls up and says – My credit is 595 and I don’t have much in post-closing liquidity. Am I going to be able to get a loan? And, I say –No, what are you doing? You just signed a no mortgage contingency clause on a contract and you put down $120,000 on a $1.2 million purchase? The buyer usually says – Well, my banker at XYZ bank said it was ok.

So, I still see that a lot in the industry. They really need to work with someone who is well-educated, understands the underwriting process very well, will vet their file and will give them a good guideline of where they can go. So, it should start at the very beginning.

When consumers are shopping for the lowest rate, how do you suggest they go about getting the best rate? And, is it all about the rate or the pace of service and attention that the bank may provide as well?
The most important thing when a person applies for a mortgage is that they get the mortgage. You can quote any rate, but what is the chance of delivering that rate? I get this a lot. People say – Well, somebody quoted me this here and somebody quoted me that there. But that provider may not have a great reputation in delivering the rate. Shopping for the rate is still very difficult and the Fed and CFPB have not been able to figure this out, especially since rates are so compressed. It used to be that the rate difference from one provider to the next could be a one percent difference. And now maybe it is a quarter of a percent. You have to look at the best rate not when you apply, but when you lock. You usually lock only when know you can close within the lock period of 15, 30, 45, or 60 days.

But, how do you know you are getting the best rate ahead of a lock? You have already made an application with someone like me and three weeks later we lock the rate, but you say – Hey, this guy over here on the web is quoting one eighth lower. It is virtually impossible to know if that person is giving an accurate rate and if you can even qualify for that bank’s rate because your file has not been vetted by that bank. Instead, you have to go to a provider like myself, someone trusted, who has been in the industry for many, many years and who will read the disclosures carefully with you. That is the key. For the most part, since rates are compressed, when you get to somebody who is well-educated and has a good reputation, you are not going to see much of a rate difference.

Ultimately, it is about the execution. And, the execution can be very difficult if it is not done right.

Appraisals. How often are you seeing appraisals kill a deal in this market?
It’s a big deal. An appraisal is a comparison of the subject property to closed sales. What did similar homes or apartments sell for in the past six months? When you have a rising market like you do in certain areas of Brooklyn, it’s hard to justify some of these values. So, the realtor has to be very sharp and know every possible listing and closing that has occurred while that appraiser has inspected the property and before that report is done – and keep that appraiser informed. Loan officers are not allowed to have contact with the appraiser, but there is nothing stopping the realtor or the owner of the apartment from handing him good comparables.

You would think that the appraiser would do a thorough job, but unfortunately, and I feel for the appraisers, their industry has been gutted. You used to have good appraisers that considered themselves experts in certain areas. I had a great appraiser for the Upper West, one for Upper East Side, downtown, Westchester, Long Island, etc. They knew every street and every house. Their whole life was – they lived there and worked there for twenty years. They were truly professionals. The problem is that when the debacle hit, Cuomo came in and as Attorney General of New York, he went to Fannie and Freddie and said – We are changing this process. You want to close loans in my state? You have to do it this way. He used to regulate Fannie and Freddie when he was in the Clinton Administration, so they followed his lead.

We had a new appraisal rule put into effect. Bank loan officers and brokers cannot have any contact at all with the appraiser. We have to go through a buffer, which is called an appraisal management company (AMC). We order the appraisal with the AMC, the AMC has full contact with the appraiser. And, if we have comments? We can only feed it to the AMC. Now the AMC takes a piece of the pie. They’re supposed to hire the best local appraisers, but they don’t. Most of the time, they are not local! Real estate is local. That is the problem with this AMC system. It should have been done much differently. It is really a shame that Cuomo had very good intentions, which were to get rid of the subprime world, but the execution has destroyed the industry. It’s another major problem in this industry – the appraisal process.

I’m going to jump around a bit. How do you, if at all, work with foreign buyers to get financing?
We deal with foreign buyers all the time. First is the “KYC Rule,” which is Know Your Client because there are strict anti-money laundering laws. They are very strict about it and you have to trace all of the funds. The first thing is that banks will not deal with people from certain countries – Iran, Venezuela, Russia. They will not give financing unless these people have dual citizenship somewhere else. The second thing is that they try to verify their income. We verify with a notarized CPA letter because a notary carries a lot more weight in other countries. We verify their bank statements going back two to three months to make sure that there is no funny business.

I am doing a transaction now for a French citizen who works in the UK and gets paid in Sterling and he is buying a second home here in the US. I was able to trace everything about his income – his assets and even his credit. We showed two months of statements and a transfer to a local checking account and that was it.

Foreign financing is readily available. We do a lot of transactions with foreign buyers both on second homes and primary residences and as investors in co-ops and condos.

Jumping around again, but the question on many people’s minds – how has Hurricane Sandy changed the mortgage industry?
So Hurricane Sandy came in and everybody knows that FEMA started redrawing the flood hazard maps. Now, a lot of homes are in a worse grade, meaning that they are more likely to flood, which makes it harder and more costly to get flood insurance. Also, people who were not in a flood zone are now in a flood zone. This has pushed up the cost of flood insurance and made it hard, if not impossible to obtain flood insurance.

So, what does that mean? A number of banks have said that if you are in a certain flood zone, then they want full replacement cost on the home, which could cost $10 to $20,000 per year. Not just a FEMA flood policy, which could be very de minimus. So, in New York City, you have a building that is in a flood hazard area. The building must maintain flood insurance, which varies based on the number of units in the building. But! Those units that are on the first or second floor usually require additional, supplemental flood insurance. So, you always vet that immediately with the bank to see if they require full replacement. That is why I keep saying that it is all about the execution, not just the rate.

Final thoughts?
I made the move to Sterling because of the platform, the ethos of this bank. They are highly regarded by the regulators, by the community and they service not just the mortgage market, but also the small to middle lending market for asset-based lending, factoring, business lending – commercial and industrial and are very competitive in that space. It is very important to them that every business channel feeds on another. And, they are doing a very good job from what I can tell. Plus, their mortgage processors, underwriters and closers are all located here in the New York-area. They are excellent at closing the transaction.