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Diane Gallagher

Who determines if you are qualified for a mortgage loan?

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Posted: Friday, September 14, 2012 12:00 am

Banks are the key to the availability and cost of mortgage loans, but bank regulators are also. As directed by the Dodd-Frank financial reform, regulators will soon make some important decisions affecting who can obtain mortgages and what interest rates will prevail.

One key decision involves the definition of what the Dodd-Frank law calls a “qualified mortgage.” A qualified mortgage will be one that a household can reasonably be expected to repay. This definition needs to be crystal clear.

Definitions left open for interpretation will leave lenders uncertain and maybe overly cautious restricting credit and crippling the market.

According to the Washington Post, Mark Zandi,  Lenders probably will only make qualified mortgages, because if the loans ever go into default, they could be sued by disgruntled borrowers. The legal and reputational costs would be prohibitive. How qualified mortgages are defined, therefore, will essentially set the boundaries of the U.S. mortgage market. Deciding which loans will qualify will be tricky. Lenders look at potential borrowers from many angles before extending credit: How much of its income will a household need to put into debt repayment? How large is the down payment? Does the borrower have a job with a stable income? What is the borrower’s credi score?

Mortgage loans can also vary widely, with features that make sense for one borrower but not for another. If the government becomes too tight with the definition of qualified, it will become even harder than it is now. For lower income and first time home buyers this could mean that they do not qualify for a loan.

Here is a second decision with big implications for mortgage credit, it involves something called the “qualified residential mortgage” rule. The name is similar, but quite different from the qualified-mortgage definition; it is designed to curb bad lending by forcing lenders to hold a financial stake in their riskiest mortgages.

Under Dodd-Frank, a lender must hold 5 percent of any loan that isn’t a “qualified residential mortgage” so that if it later goes sour, the lender loses something, too. This makes sense in principle, but like th qualified-mortgage rule, the devil is in the details. These are quite complicated, reflecting regulators’ fear that lenders will work hard to circumvent any rule. But complexity adds to costs, and as a result, non-qualified residential mortgage loans threaten to have higher mortgag rates than qualified residential mortgage loans.

How qualified residential mortgage is defined will help shape the federal role in the mortgage market. If the definition is too narrow, private lenders won’t be able to compete, given the higher interest rate they will need to charge to compensate for the extra risk. The government will thus continue to dominate mortgage lending in the near term. On the other hand, if Fannie Mae and Freddie Mac are privatized down the road, a narrow qualified residential mortgage definition could significantly shrink the government’s role in the mortgage market, potentially threatening the existence of the  30-year fixed rate mortgage loan.

Whatever regulators decide about the qualified mortgage (QM) and the qualified residential mortgage (QRM) they need to do it quickly. Without clarity on these rules, mortgage loans will remain difficult to get, holding back housing and the economy. Clear rules also are needed so that lawmakers can finally figure out what to do about Fannie and Freddie, and the role government should play in the nation’s housing.

Diane Gallagher is the president of the Lodi Association of Realtors and can be reached at