Today's Trends in Credit Regulation

What Loan-to-Value Ratio Requirements Should Apply to “Qualified Residential Mortgages”?
By Elizabeth C. Yen

Federal regulators have issued proposed regulations concerning “qualified residential mortgages” or QRMs. Under the Dodd-Frank Act, sponsors of residential mortgage loan securitizations generally will be subject to a 5% credit risk retention requirement. However, sponsors of QRM securitizations would be exempt from this credit risk retention requirement. QRMs are supposed to be very high quality, low credit risk, prime residential mortgage loans.

Federal regulators have proposed that QRMs meet several requirements, including a 20% minimum downpayment for eligible purchase-money loans (and a proposed 70% maximum loan-to-value ratio for eligible cash-out refinancings and a proposed 75% maximum loan-to-value ratio for eligible no-cash out refinancings), subject to a possible exception for certain loans that are covered by qualifying private mortgage insurance as of closing. Borrower-paid closing costs for QRMs could not be financed under the proposal. QRMs also must be first lien priority closed-end residential mortgages secured by owner-occupied primary residences, without balloon payment features, prepayment penalties, interest-only payments, negative amortization, or certain other features. QRM borrowers also must meet certain credit requirements and QRM loans must comply with certain default mitigation servicing standards.

The 20% minimum downpayment proposal for purchase-money QRMs has generated interesting public comment letters, including one filed jointly by the Center for Responsible Lending, Consumer Federation of America, National Association of REALTORS®, and National Association of Home Builders. Their comment letter states that a 20% downpayment requirement would unnecessarily impede economic recovery and unnecessarily burden homeownership. Their comment letter suggests that even a 10% downpayment requirement might be excessive, as it could require an average individual to save for 9 years before being able to purchase a home.

Another public comment letter, filed jointly by 13 national civil rights, labor, and consumer organizations, including (among others) the AFL-CIO, NAACP, Service Employees International Union, National Association of Consumer Advocates, and National Consumer Law Center (on behalf of its low income clients), objects to the proposed 20% downpayment requirement as “unduly disadvantaging well-qualified borrowers who lack the wealth necessary for a large downpayment.”

A bipartisan group of Congressmen (including letters signed by over 120 members of the House of Representatives and 39 Senators) has requested a reduction to the proposed 20% downpayment requirement. The Federal Advisory Council to the Federal Reserve Board, composed of 12 representatives of the banking industry, advised the Federal Reserve Board in May of this year that a majority of Council members believe the proposed QRM downpayment and loan-to-value ratio requirements are too stringent and “ignor[e] the fact that well-underwritten, low down payment loans have been a significant and safe part of the mortgage finance system for decades.”

The Federal Reserve Board also received comments about the QRM proposal from its Consumer Advisory Council (CAC) on June 16, 2011. In advance of that meeting, the Independent Community Bankers of America (ICBA) wrote a comment letter to the CAC, noting (among other things) that a very restrictive definition for QRMs would significantly disadvantage community banks, because of their relative “lack of access to the increased capital required to offset risk retention requirements. ICBA is particularly concerned that community banks operating in rural areas will be driven out of the market by Farm Credit System direct lenders who are supervised by the Farm Credit Administration and who received an exemption in the [Dodd-Frank] Act for loans or other financial assets that they make, insure, guarantee, or purchase.”

Acting Comptroller of the Currency John Walsh recently observed that mortgage lenders should be allowed to “take on reasonable and manageable risks. Local communities won’t thrive without local banks that are willing to take some reasonable risk in the extension of credit and have the wherewithal to manage that risk. Families cannot buy homes and build wealth to improve their lives without lenders willing to take a chance on them. We need to make sure the pendulum doesn’t swing so far that in the process of reducing risk, we extinguish the impulse to take appropriate risks, stifle the economy, and hurt ordinary people. We need to find a middle ground that manages risk in the system without sacrificing the energy and vitality that has brought so much prosperity to so many.”[1]

One frequently articulated concern by public commenters is that if a mortgage loan does not meet QRM requirements, its interest rate will need to be higher to offset the 5% credit risk retention requirement that would be imposed on the sponsor of any securitization that includes the mortgage loan as an underlying asset. Individuals who cannot meet QRM requirements might therefore be ineligible for the lowest, most favorable interest rates available on residential mortgage loans. A higher interest rate correlates with a higher monthly payment requirement, which in turn will tend to reduce the total principal amount an individual could afford to borrow. These factors may also hinder or delay recovery of the housing market.

However, the QRM proposal would allow certain gifts, certain types of “sweat equity,” and certain types of governmental and nonprofit downpayment subsidies to be counted towards the 20% downpayment requirement, which could help certain borrowers meet QRM requirements. Securitizations of residential mortgage loans that are insured or guaranteed as to the payment of principal and interest by the United States or an agency of the United States (excluding Fannie Mae, Freddie Mac, and Federal Home Loan Banks) also would be exempt from the credit risk retention requirement. Therefore, individuals who are unable to meet QRM requirements could potentially obtain favorable interest rates (and avoid a 20% downpayment requirement) by seeking FHA, VA or similar federally insured or federally guaranteed residential mortgage financing.

Federal regulators also believe the secondary market for non-QRMs will be strong enough to keep the interest rate differential between QRMs and non-QRMs relatively small, particularly since non-QRMs will likely significantly outnumber QRMs and all consumer residential mortgage loans (including non-QRMs) will be subject to “ability to repay” underwriting requirements.[2]

Julie Williams, First Senior Deputy Comptroller and Chief Counsel of the OCC, has stated that a possible compromise between advocates of higher loan-to-value ratios and lower downpayment requirements for QRMs and federal regulators who are concerned about limiting QRMs to those residential mortgage loans that have lower default risks might be to create an intermediate class of non-QRM residential mortgage loans that would be subject to a lower (less than 5%) securitization credit risk retention requirement.[3]

Interestingly, Sheila Bair, chair of the FDIC, was recently quoted as saying that her preference would be to eliminate QRMs and subject all residential mortgage loans to a 5% credit risk retention requirement, to remove the possibility of “two-tiered pricing” for securitized QRM and non-QRM loans.[4] A public comment letter from Prudential Investment Management, Inc. has similarly advocated that QRMs be “very narrow in scope” to avoid potential market manipulation.

Under the proposed QRM requirements, FHA, VA and other federally insured and federally guaranteed mortgage programs could become more significant sources of home financing, potentially taking over (at least in part) roles previously occupied by Freddie Mac and Fannie Mae. Representatives of the private mortgage insurance industry (as well as members of Congress) have advised federal regulators that private mortgage insurance should be allowed to count towards QRM downpayment and loan-to-value ratio requirements. Otherwise, the FHA, VA and other federal government loan insurance and loan guaranty programs might become the primary source of low downpayment and higher loan-to-value ratio mortgage loans, creating a potentially dangerous concentration of default risk in taxpayer-subsidized federal loan programs.

A similar 20% downpayment requirement has been proposed for purchase-money automobile-secured consumer loans, as one of several conditions for exemption from the 5% credit risk retention requirement generally imposed by the Dodd-Frank Act on asset-backed securitization sponsors. This would apparently make securitizations of purchase-money automobile loans that include financed “negative equity” ineligible for a credit risk retention exemption.

The market for affordable personal automotive transportation presently gives certain eligible consumers the option of entering into long-term leases of automobiles, which in many instances may reduce the consumers’ required initial monthly payments (and some consumers also may have a purchase option that is exercisable at the end of the lease term). The QRM proposal, once it is finalized, similarly could make certain long-term residential leasing options more attractive to consumers, and might pave the way for creative “rent to own” agreements between consumers and residential real estate investors.

The credit risk retention proposal is lengthy and detailed, occupying over 95 pages in the April 29, 2011 Federal Register. The proposed QRM downpayment and loan-to-value ratio requirements are only one small piece of the proposal. The deadline for public comments on the credit risk retention proposal was extended to August 1, 2011 at the request of various industry and consumer associations (including the American Bankers Association and The Loan Syndications and Trading Association, among others), to give interested parties more time to compile historical data about the credit risk associated with certain types of residential mortgage loans, in order to support suggested revisions to the proposal. (The deadline for public comments on a tangentially related Federal Reserve Board proposal concerning “qualified mortgages” that would be presumed to meet certain Dodd-Frank Act “ability to repay” requirements is July 22, 2011.)

The credit risk retention rules, once finalized, would be generally effective for securitizations of residential mortgage loans issued one year or more after publication of the final rules, and for other securitizations (including securitizations of purchase-money automobile-secured consumer loans) issued two years or more after publication of the final rules. These rules implicate somewhat conflicting and divergent public policies and economic interests, and might be subject to additional federal legislation down the road.

Elizabeth C. Yen is a partner in the Connecticut office of Hudson Cook, LLP. Elizabeth can be reached at 203-776-1911 or by email at

[1]See May 19, 2011 speech before the Housing Policy Council of The Financial Services Roundtable, copy available at

[2]See, e.g., June 9, 2011 speech of Federal Reserve Board Vice Chair Janet L. Yellen at the 2011 Federal Reserve Bank of Cleveland Policy Summit, copy available at

[3]See April 14, 2011 testimony before the Subcommittee on Capital Markets and Government Sponsored Entities, Financial Services Committee, U.S. House of Representatives, copy available at

[4]See June 9, 2011 transcript of remarks before the Council on Foreign Relations, copy available at

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