New mortgage rules issued last week by the administration will have the effect of forcing lenders to approve prime loans to borrowers who would normally only qualify for subprime loans carrying higher interest rates and fees to cover the added risk of default.
Banks are already under renewed pressure from federal prosecutors and regulators to make home loans to low-income borrowers with blemished credit as part of the administration’s stepped-up enforcement of anti-redlining laws.
Before the mortgage crisis, lenders were able to hedge losses by placing such homebuyers in higher-cost subprime mortgages—something the government at one point actually encouraged as part of a strategy to expand credit opportunities for lower-income minorities and close the racial “mortgage gap.”
But under the new mortgage rules, loans with subprime features do not fall under the official government definition of “qualified mortgages,” and therefore do not provide a “safe harbor” against lawsuits and other action.
As a result, analysts warn lenders may end up having to “subsidize” riskier borrowers at the expense of other customers.
The Consumer Financial Protection Bureau, the Dodd-Frank Act-created agency that wrote the 800-page mortgage regulation, has decreed that the way to distinguish a prime loan from a subprime loan is by the interest rate charged, even though the main distinguishing feature of a subprime loan is a sub-660 credit score.
“Under its tortured definition of ‘prime,’ a borrower can have no down payment, a credit score of 580, and a debt (-to-income) ratio over 50%,” as long as the borrower is charged a prime rate, said former Fannie Mae chief credit officer Edward Pinto.
Mortgages carrying a prime rate, or one within 1.5 percentage points of the national average, will have the strongest level of legal protection, according to the regulator. Analysts say this rule effectively limits lenders’ ability to price for risk. Lenders who charge rates above the 1.5-point threshold open themselves up to legal liability.
Starting in January 2014, when the new rules take effect, borrowers who default on nonqualifying home loans will have the power to “raise a foreclosure defense” against banks, according to Joseph Barloon, a lawyer for New York-based Skadden, Arps, Slate, Meagher & Flom.
In addition, lenders who underwrite such nonqualifying loans could open themselves up to federal charges if recipients are minorities.
CFPB has the power to enforce “fair lending” laws, and is already coordinating lending-discrimination cases against banks with the Justice Department.
As part of recent consent decrees, Justice has ordered several bank defendants to approve prime-rate mortgages for African-Americans and Latinos who otherwise would not qualify for them.