During the housing boom, a borrower's ability to exhale appeared to be the chief criterion for obtaining a mortgage. Six years of record foreclosures later, with millions of borrowers owing more than their properties are worth, the housing market continues to tread water.
To prevent this from happening again, the Dodd-Frank financial-reform act of 2010 required that changes be made. The chief targets: such mortgage instruments as "interest-only" and "negative-amortization" loans, both of which allowed marginal borrowers to buy more house than they could have ever possibly afforded.
Those were risky loans even in good financial times, but when the market collapsed, failure to meet even interest payments cost hundreds of thousands of borrowers their houses. To meet the reform law's mandate, the Consumer Financial Protection Bureau, another Dodd-Frank creation, is designing what is known as a "qualified residential mortgage."
With a summer deadline for this new "Ability to Repay" rule, there is heightened concern in the housing industry that a highly restrictive regulation will cut more borrowers out of the market than the situation warrants.
"In typical government fashion, they will create a solution to a problem that doesn't exist," said Jerome Scarpello, of Leo Mortgage in Ambler. "The subprime loans and no-income-verification loans are gone. The underwriting criteria currently in place [are] hard enough without smothering the little improvement I see in the market."
What Dodd-Frank mandated was a rule requiring institutions that place securities in the asset-backed secondary market to have a financial stake in ensuring that mortgage products are quality products.
But opponents maintain that by requiring high down payments intended to guarantee quality — thus creating what are called "gold-plated mortgages" — prospective borrowers who don't qualify for them would be forced into a higher-priced home-loan market lacking the same guarantees and protections.
The Center for Responsible Lending, which typically stands on the opposite side of the fence from lenders, has cited research concluding that the government's proposals might, indeed, end up being too restrictive.
That research, conducted by both the center and the Center for Community Capital, found that such rules could push 60 percent of creditworthy borrowers into high-cost loans or out of the market entirely. Their findings were based on an analysis of almost 20 million mortgages made between 2000 and 2008.
Government proposals have called for down payments of up to 20 percent, but the research showed that "mandating large down payments would be a mistake for business and consumers."
For example, the centers said, home mortgages requiring a 10 percent down payment would lock 40 percent of all creditworthy borrowers out of the market. A 20 percent down payment would exclude 60 percent of the same borrowers.
"While higher down payments do result in fewer defaults, restricting QRM [qualified residential mortgage] loans to borrowers who can come up with a 10 percent down payment would exclude nine creditworthy borrowers to prevent just one foreclosure," the centers stated.
Substandard underwriting, not low down payments, contributed to the housing industry's current woes, the centers maintain.
Based on the $172,900 median price of a house in 2010 and adding in closing costs of 5 percent of the purchase price, the centers said, it would take a construction worker earning $40,650 a year 24 years to come up with a 10 percent down payment.
A registered nurse earning $64,690 a year could do it in 15 years, while a police officer making $53,540 annually would make the 10 percent in 18 years.
"I think it's a bad idea all around and will mostly affect first-time buyers, minorities, and low-income home buyers — all the keys to any economic recovery," Scarpello said.
"Down-payment standards are not enough to prevent another housing meltdown," said Mark Zandi, chief economist at Moody's Analytics in West Chester. "Most important to preventing bad lending [including mortgage lending] are higher capital ratios and tougher liquidity requirements for banks and other creditors."
Zandi said consistent stress testing of financial institutions "is also very important to ensuring they have enough capital and liquidity to weather difficult economic times."
Predictably, the housing industry is unequivocally opposed to raising down payments to 20 percent, or even 10 percent.
This week, a letter signed by 33 groups representing real estate agents, builders, and lenders, among others, urged the Consumer Financial Protection Bureau to come up with a rule that would not "undermine prospects for a housing recovery and threaten the redevelopment of a sound mortgage market."
"Congress intended that all creditworthy borrowers — especially low- and moderate-income borrowers and families of color — should be extended the important protections of a qualified mortgage," the letter stated.
What the groups seek to help "ensure revival of the home-lending market" is "a broad qualified mortgage, which includes sound underwriting requirements, excludes risky loan features, and gives lenders reasonable protection against undue litigation risk."
Builders, especially, have argued that tighter lending standards not only have kept buyers away but have prevented construction jobs from being created in markets that did not take major economic hits and could do with more houses.
"Today's underwriting standards are too restrictive and are holding back a housing recovery," the organizations said.