REFinBlog

Editor: David Reiss
Brooklyn Law School

April 27, 2017

Community Bankers and GSE Reform

By David Reiss

The Independent Community Bankers of America have release ICBA Principles for GSE Reform and a Way Forward. Although this paper is not as well thought-out as that of the Mortgage Bankers Association, it is worth a look in order to understand what drives community bankers.

The paper states that the smaller community banks

depend on the GSEs for direct access to the secondary market without having to sell their loans through a larger financial institution that competes with them. The GSEs help support the community bank business model of good local service by allowing them to retain the servicing on the loans they sell, which helps keep delinquencies and foreclosures low. And unlike other private investors or aggregators, the GSEs have a mandate to serve all markets at all times. This they have done, in contrast to some private investors and aggregators that severely curtailed their business in smaller and economically distressed markets, leaving those community bank sellers to find other outlets for their loan sales. (1)

The ICBA sets forth a set of principles to guide GSE reform, including

  • The GSEs must be allowed to rebuild their capital buffers.
  • Lenders should have competitive, equal, direct access on a single-
    loan basis.
  • Capital, liquidity, and reliability are essential.
  • Credit risk transfers must meet targeted economic returns.
  • An explicit government guarantee on GSE MBS is needed.
  • The TBA market for GSE MBS must be preserved.
  • Strong oversight from a single regulator will promote sound operation.
  • Originators must have the option to retain servicing, and servicing fees must be reasonable.
  • Complexity should not force consolidation.
  • GSE assets must not be sold or transferred to the private market.
  • The purpose and activities of the GSEs should be appropriately limited.
  • GSE shareholder rights must be upheld.

This paper does not really provide a path forward for GSE reform, but it does clearly state the needs of community bankers. That is valuable in itself. There is also a lot of common sense behind the principles they espouse. But it is a pretty conservative document, working from the premise that the current system is pretty good so if it ain’t broke, why fix it? I think other stakeholders believe the system is way more broke than community bankers believe it to be.

There are also some puzzlers in it this paper. Why the focus on GSE shareholder rights? Is it because many community banks held GSE stock before the financial crisis? Are there other reasons that this is one of their main principles?

Hopefully, over time community bankers will flesh out the thinking that went into this paper in order to fuel an informed debate on the future of the housing finance market.

 

 

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April 27, 2017 | Permalink | No Comments

April 26, 2017

Comparison Shopping Savings in Mortgage Market

By David Reiss

Alexei Alexandrov and Sergei Koulayev of the Consumer Financial Protection Bureau have posted a working paper, No Shopping in the U.S. Mortgage Market: Direct and Strategic Effects of Providing Information to SSRN. The paper is the first to answer the question, “How much do consumers lose by not shopping enough for mortgages?” (5) They find that “for the average consumer, the the difference between the actual and the lowest offered rate amounted to an extra $300 per year.” (Id.)

The abstract reads,

We document and analyze price dispersion in the U.S. mortgage market. We find significant price dispersion in posted prices in the retail channel: for example, a consumer with a prime credit score and with a 20% down payment might see a spread in interest rates of 50 basis points, controlling for all relevant consumer/property characteristics, including discount points. We also show, from survey evidence, that close to half of consumers did not shop before taking out a mortgage, and worse, many consumers do not seem to realize that there is price dispersion. Using a proprietary dataset of lenders’ ratesheets, we estimate an equilibrium model of costly search where a share of consumers holds incorrect beliefs regarding price dispersion. Whereas high search costs is one reason behind the lack of search, we show that non-price preferences also play an important role in preventing consumers from searching more; and so an effective policy would target both. In one of our counterfactuals, we show that eliminating non-price preferences results in savings of about $9 billion dollars a year.

In addition to its significant finding on a new topic (one that should have policy implications for the Consumer Financial Protection Bureau), the paper also demonstrates the value of government research on the mortgage markets.

The paper relies on data from the National Survey of Mortgage Originations. The NSMO is a survey designed by the CFPB and the Federal Housing Finance Agency.  It is sent out on a quarterly basis to a nationally representative sample of recent mortgage borrowers. Jeb Hensarling (R-TX), the Chair of the House Financial Services Committee, has introduced legislation to stop the CFPB from conducting research on the mortgage markets. That would be a bad result for consumers.

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April 26, 2017 | Permalink | No Comments

Wednesday’s Academic Roundup

By Robert Engelke

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April 26, 2017 | Permalink | No Comments

April 25, 2017

Budding GSE Reform

By David Reiss

The Mortgage Bankers Association has released a paper on GSE Reform: Creating a Sustainable, More Vibrant Secondary Mortgage Market (link to paper on this page). This paper builds on a shorter version that the MBA released a few months ago. Jim Parrott of the Urban Institute has provided a helpful comparison of the basic MBA proposal to two other leading proposals. This longer paper explains in detail

MBA’s recommended approach to GSE reform, the last piece of unfinished business from the 2008 financial crisis. It outlines the key principles and guardrails that should guide the reform effort and provides a detailed picture of a new secondary-market end state. It also attempts to shed light on two critical areas that have tested past reform efforts — the appropriate transition to the post-GSE system and the role of the secondary market in advancing an affordable-housing strategy. GSE reform holds the potential to help stabilize the housing market for decades to come. The time to take action is now. (1)

Basically, the MBA proposes that Fannie and Freddie be rechartered into two of a number of competitors that would guarantee mortgage-backed securities (MBS).  All of these guarantors would be specialized mortgage companies that are to be treated as regulated utilities owned by private shareholders. These guarantors would issue standardized MBS through the Common Securitization Platform that is currently being designed by Fannie and Freddie pursuant to the Federal Housing Finance Agency’s instructions.

These MBS would be backed by the full faith and credit of the the federal government as well as by a federal mortgage insurance fund (MIF), which would be similar to the Federal Housing Administration’s MMI fund. This MIF would cover catastrophic losses. Like the FHA’s MMI fund, the MIF could be restored by means of higher premiums after the catastrophe had been dealt with.  This model would protect taxpayers from having to bail out the guarantors, as they did with Fannie and Freddie at the onset of the most recent financial crisis.

The MBA proposal is well thought out and should be taken very seriously by Congress and the Administration. That is not to say that it is the obvious best choice among the three that Parrott reviewed. But it clearly addresses the issues of concern to the broad middle of decision-makers and housing policy analysts.

Not everyone is in that broad middle of course. But there is a lot for the Warren wing of the Democratic party to like about this proposal as it includes affordable housing goals and subsidies. The Hensarling wing of the Republican party, on the other hand, is not likely to embrace this proposal because it still contemplates a significant role for the federal government in housing finance. We’ll see if a plan of this type can move forward without the support of the Chair of the House Financial Services Committee.

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April 25, 2017 | Permalink | No Comments

Tuesday’s Regulatory & Legislative Roundup

By Robert Engelke

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April 25, 2017 | Permalink | No Comments

April 24, 2017

What is the Debt to Income Ratio?

By David Reiss

OppLoans.com quoted me in What is the Debt to Income Ratio? It opens,

One of the great things about credit is that it lets you make purchases you wouldn’t otherwise be able to afford at one time. But this arrangement only works if you are able to make your monthly payments. That’s why lenders look at something called your debt to income ratio. It’s a number that indicates what kind of debt load you’ll be able to afford. And if you’re looking to borrow, it’s a number you’ll want to know.

Unless your rich eccentric uncle suddenly dies and leave you a giant pile of money, making any large purchase, like a car or a home, is going to mean taking out a loan. Legitimate loans spread the repayment process over time (or a longer term), which makes owning these incredibly expensive items possible for regular folks.

But not all loans are affordable. If the loan’s monthly payments take up too much of your budget, then you’re likely to default. And as much as you, the borrower, do not want that to happen, it’s also something that lenders want to avoid at all costs.

It doesn’t matter how much you want that cute, three-bedroom Victorian or that sweet, two-door muscle car (or even if you’re just looking for a personal loan to consolidate your higher interest credit card debt). If you can’t afford your monthly payments, reputable lenders aren’t going to want to do business with you. (Predatory payday lenders are a different story, they actually want you to be unable to afford your loan. You can read more about that shadiness in our personal loans guide.)

So how do mortgage, car, and personal lenders determine what a person can afford before they lend them? Well, they usually do it by looking at their debt to income ratio.

What is the debt to income ratio?

Basically, it’s the amount of your monthly budget that goes towards paying debts—including rent or mortgage payments.

“Your debt to income ratio is benchmark metric used to measure an individual’s ability to repay debt and manage their monthly payments,” says Brian Woltman, branch manager at Embrace Home Loans (@EmbraceHomeLoan).

“Your ‘DTI’ as it’s commonly referred to is exactly what it sounds like. It’s calculated by dividing your total current recurring monthly debt by your gross monthly income—the amount you make before any taxes are taken out,” says Woltman. “It’s important because it helps a lender to determine the proper amount of money that someone can borrow, and reasonably expect to be paid back, based on the terms agreed upon.”

According to Gerri Detweiler (@gerridetweiler), head of market education for Nav (@navSMB), “Your debt to income ratio provides important information about whether you can afford the payment on your new loan.”

“On some consumer loans, like mortgages or auto loans, your debt to income ratio can make or break your loan application,” says Detweiler. “This ratio typically compares your monthly recurring debt payments, such as credit card minimum payments, student loan payments, mortgage or auto loans to your monthly gross (before tax) income.”

Here’s an example…

Larry has a monthly income of $5,000 and a list of the following monthly debt obligations:

Rent: $1,200

Credit Card: $150

Student Loan: $400

Installment Loan: $250

Total: $2,000

To calculate Larry’s DTI we need to divide his total monthly debt payments by his monthly income:

$2,000 / $5,000 = .40

Larry’s debt to income ratio is 40 percent.

David Reiss (@REFinBlog), is a professor of real estate finance at Brooklyn Law School. He says that the debt to income ratio is an important metric for lenders because “It is one of the three “C’s” of loan underwriting:

Character: Does a person have a history of repaying debts?

Capacity: Does a person have the income to repay debts?

Capital: Does the person have assets that can be used to retire debt if income should prove insufficient?

What is a good debt to income ratio?

“If you listen to Ben Franklin, who subscribed to the saying ‘neither a borrower nor lender be,’ the ideal ratio is 0,” says Reiss. But he adds that only lending to people with no debt whatsoever would put home ownership out of reach for, well, almost everyone. Besides, a person can have some debt on-hand and still be a responsible borrower.

“More realistically, in today’s world,” says Reiss, “we might take guidance from the Consumer Financial Protection Bureau (CFPB) which advises against having a DTI ratio of greater than 43 percent. If it creeps higher than that, you might have trouble paying for other important things like rent, food and clothing.”

“Requirements vary but usually if you can stay below a 33 percent debt-to-income ratio, you’re fine,” says Detweiler. “Some lenders will lend up to a 50 percent debt ratio, but the interest rate may be higher since that represents a higher risk.”

For Larry, the guy in our previous example, a 33 percent DTI would mean keeping his monthly debt obligations to $1650.

Let’s go back to that 43 percent number that Reiss mentioned because it isn’t just an arbitrary number. 43 percent DTI is the highest ratio that borrower can have and still receive a “Qualified Mortgage.”

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April 24, 2017 | Permalink | No Comments

Monday’s Adjudication Roundup

By Robert Engelke

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April 24, 2017 | Permalink | No Comments