Who Will Bear Higher Rates Under QRM?

In an earlier post, I discussed how the proposed QRM rule will raise mortgage rates for borrowers whose loans would not meet the requirements of a qualified residential mortgage.  Here, I will focus on the size of the market that will likely bear these higher rates and how it will fall disproportionally on first-time and minority borrowers.  The impact of QRM regulation will cast far beyond these two groups as higher rates will retard home sales, lower home prices, and likely impact the greater economy.

The QRM rule, if enacted, would restrict eligibility to a small sliver of the mortgage market.  From 1997 through 2003, prior to the housing boom and bust, only 18% to 22% of the market would have qualified as a QRM according to the Federal Housing Finance Agency (FHFA).[1] However, this estimate is likely an overstatement of the share of the market that would qualify under the QRM as written.  The pool of loans used by the FHFA was restricted to those that were originated by Fannie Mae or Freddie Mac.  As such, the quality of these loans tends to be higher than those held in private portfolios or those that are privately securitized.  Consequently, it is reasonable to assume that less than 18% to 22% would actually qualify for the lower mortgage rates under QRM.

In addition, the QRM would exclude a disproportionate share of minority and first-time buyers.   As evidenced by data from the 2009 American Housing Survey, Black and Hispanic borrowers are more likely to make smaller down payments than all other racial groups.  Roughly 50% of African American and Hispanic borrower put down 15% or less for their downpayment.[2] Excluding these groups, the share is 34%...a large drop.

Furthermore, Black and Hispanic home buyers are more likely to rely on savings to finance their home purchase and less likely to use inheritance, gifts, investments or proceeds from the sale of a previous home than other racial groups.  The current downpayment requirement of the QRM would narrow the field of affordable financing options for most Black and Hispanic borrowers to FHA and VA loans.

The QRM would also have an unsettling impact on the ability of first-time buyers to enter the market.  Like Black and Hispanic borrowers, first-time borrowers have relied heavily on savings to finance their home purchase.  Over the period from 2006 through 2010, the average annual share of first-time homebuyers who used a mortgage and financed more than 80% of their home purchase was 86.8%.[3] Not surprisingly, repeat buyers were less reliant on savings, likely because they were able to use the proceeds from previous home sales in their subsequent purchase.  The large down payment requirements of the QRM would effectively undermine the process of trade-up buying as fewer first-time buyers would be able to enter the market, forcing would-be trade up buyers to stay in place.  With the impending surge of baby boomers seeking to downsize, this impediment could hamstring the plans of another large segment of the population and reduce the mobility of the workforce.

Finally, it is not clear that the private sector has the ability to absorb the GSE’s share of the securitization market.  If they do not, and the role of the Federal Housing Agency is reduced, the gap that remains would likely leave those least able to save or those with weaker credit with limited access to mortgage credit.  This process would be exaggerated during periods of weakness for the economy or housing market as lenders restrict credit to borrowers perceived as safer; those borrowers who meet the QRM or are close to it.

The reach of the QRM is likely to be more broadly felt than just first-time buyers and minorities groups.  Research conducted by economists at Economy.com[4] found that an increase in mortgage rates of 100 basis points would reduce home sales by roughly 425,000 per year and depress the median existing home price by 8.5%.  An increase of rates by 150 basis points would have an even stronger impact, reducing home sales by nearly 690,000 units annually and causing prices to fall 13.8%.  Furthermore, the economists at Economy.com point out that the estimates are not linear and that, “the estimates…are based on raising the fixed mortgage rate from 6% to 7%. The housing market impacts would be measurably greater if fixed rates were to rise from say 7% to 8%.”  While the average 30-year fixed rate mortgage is below 5.0% today, it is likely to rise over the next 5 to 10 years with inflation and economic growth.  A simple forecast of long-term mortgage rates using the Congressional Budget Office’s January forecast of the 10-year Treasury and the historical spread between the 30-year fixed rate mortgage published by Freddie Mac and the 10-year Treasury places the average 30-year fixed rate mortgage at 6.5% for 2013 through 2016 and roughly 7.2% for 2017 through 2020.

Under the proposed rules for a qualified residential mortgage, borrowers who do not qualify are likely to face higher mortgage rates.  These rates will fall on a large share of borrowers, but are expected to have a sharper impact on minority and first-time homebuyers, two groups that have historically relied on low downpayment loans.  However, the higher rates under the QRM rule are will have a more chilling effect that would lower home sales and reduce home prices for the entire market.

[1] http://www.fhfa.gov/webfiles/20686/QRM_FINAL_ALL_R41111.pdf

[2] The 16% to 20% category was excluded because many borrowers put down exactly 20% to get better mortgage rates.  These loans would meet the QRM requirement for downpayment.

[3] The National Association of REALTORS®. Profile of Home Buyers and Seller, Washington, DC. 2005 through 2010

[4] http://www.economy.com/mark-zandi/documents/Reworking-Risk-Retention-062...