Last fall the Urban Institute (UI) published a paper asking, "What, if anything, should replace the QM Patch?" Now Laurie Goodman, UI's Vice President, Housing Finance Policy, is writing that, as the patch's expiration nearing, new evidence shows an answer to that question is becoming crucial.
The "patch" is part of the qualified mortgage (QM) rule developed by the Consumer Financial Protection Bureau (CFPB) to implement the Ability to Repay (ATR) portion of The Dodd-Frank Wall Street Reform and Consumer Protection Act.
The ATR rule requires that lenders make a reasonable and good faith determination of a borrower's ability to repay a loan taking into consideration income, assets, debt, and employment. One way in which a lender can comply with the ATR rule is through originating a QM. A general QM requires a debt-to-income (DTI) ratio of 43 percent. However, as the FHA, VA, and USDA have different rules on debt, they were excluded from the DTI limit, leaving it only to apply to the GSEs Freddie Mac and Fannie Mae and non-government affiliated lenders.
After the rule was implemented this was corrected with the "patch" which allows lenders to obtain the "safe harbor" afforded by the ATR rule as long as a QM loan they originate is otherwise eligible for purchase by one of the GSEs. The Safe Harbor protects lenders from lawsuits that maintain they failed to appropriately qualify a borrower's repayment ability.
The GSE patch is set to expire on January 10, 2021 or when the GSEs are released from government conservatorship, whichever comes earlier.
Goodman used databases developed by Recursion Company, a financial analytics firm, to show why it's important to address the expiration of the patch. The principal reasons she presents is that the patch disproportionately benefits minority and low-income borrowers. Should it be allowed to expire in less than two years without some type of fix, it will further disadvantage those underserved groups.
The QM rule, she says, eliminated the riskiest loans, those requiring interest only or balloon payments or adjustable rate mortgages that might result in negative amortization. As further safeguard is that loans sold to GSE including those covered by the GSE patch, must still go through the rigorous GSE underwriting process.
The patch went into effect in 2014, and approximately 19 percent of GSE loans from then through 2018, 3.3 million loans, were made possible by the patch. The number of those loans was rising in the latter part of the period as interest rates as well as home prices rose. These factors forced many homebuyers to borrow more in comparison with their incomes, while higher rates had an additional impact on their monthly payments and debt ratio.
The CFPB is currently deciding the fate of this patch-whether to keep it in place, let it expire, or modify it and Goodman says it would be helpful to know who it serves in terms of race, ethnicity, and income. Until now that information has not been available in publicly available origination data.
Li Chang of Recursion has matched data collected through the Home Mortgage Disclosure Act (HMDA) which does contain race, ethnicity, and income information, with GSE origination data. Goodman says the results are not surprising but do quantify and confirm that high DTI borrowers through the GSEs are disproportionately minorities with incomes that average less than borrowers with lower DTIs.
Chang's work illustrates that as DTIs increase, the proportion of white borrowers decreases, and the proportion of all other minority borrowers increases. For example, only 3.5 percent of loans with DTI's under 43 percent are made to African Americans, and 6.4 percent are made to Hispanics. The percentage of loans over 43 percent made to the two racial groups were 4.5 percent and 8.9 percent respectively. This suggests that African Americans are 29.0 percent more likely to have a loan permitted by the patch than allow without it as were 38 percent more Hispanics. The results were consistent for both purchase and refinance loans; minority borrowers are overrepresented in the higher DTI buckets.
Also, as DTIs increase, incomes decline. The income of borrowers with DTIs over 43 is 10 to 15 percent lower than the income of borrowers with DTIs less than or equal to 43 DTI. This is true for all races and ethnicities. For non-Hispanic whites, for example, the median income was $92,000 for those with the lower DTIs and $79,000 for those over 43 percent. For African Americans with higher DTIs the median was $80,000, compared with $75,000 for those within the non-patch bucket. For Hispanic borrowers, the difference is $72,000, compared with $67,000 respectively.
Asian Americans, who tend to live in the higher cost areas and thus have the highest incomes, the pattern is still the same. Those with lower DTIs have a median income of $111,000, compared with $92,000 for those on the higher end.
Goodman concludes, "This new evidence firmly establishes that the GSE patch disproportionately benefits minority borrowers and borrowers whose incomes are at the lower end for new homeowners. This finding suggests that if the patch is not extended, a replacement should be found that supports credit availability for minority borrowers."