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Wall Street Reform Boosts FHA Mortgages

by Peter G. Miller
June 28th, 2010

The Wall Street Reform and Consumer Protection Act is now shaping up and at this writing a big winner is the FHA mortgage program. Given new rules FHA loans are going to become very popular, very quickly.

To see what’s going on here, we first have to start with the reality that the measure runs 1,616 pages. Deep inside the legislation is language which creates what will be known as a “qualified mortgage.”

A “qualified mortgage” is a home loan with certain characteristics. It does not allow negative amortization, prepayment penalties or require a balloon payment. The loan application must be fully documented.

If you’re a lender and want to originate qualified mortgages because there are big penalties if you don’t. For instance, you have to set aside 5 percent of the mortgage amount in a reserve. That may not sound like a big deal but bigger reserves reduce the ability of lenders to make loans, which means that bigger reserves also reduce the ability of lenders to make profits.

Oh, and if a loan is not a qualified mortgage then prepayment penalties are not allowed.

FHA Loans

If you look at the standards for qualified mortgages what you see is that conventional, and federally-insured loans such as those from the VA and FHA will readily qualify.

What won’t qualify are the very loans which caused the popularity of FHA financing to fall in 2004, 2005 and 2006 — the heyday of the toxic mortgage.

Nope, under the qualifying mortgage rules you can’t have an option ARM because it allows for negative amortization. You can’t have a no doc or low doc loan application because the income and employment verifications are insufficient. You can’t have an interest-only loan because by definition it allows “a consumer to defer repayment of principal or interest” and that’s a no-no under the legislation.

Accountability

To make matters more interesting, the House Financial Services Committee says the new rules have teeth: “Lenders and mortgage brokers who don’t comply with new standards will be held accountable by consumers for as high as three-years of interest payments and damages plus attorney’s fees.”

So, if you were a lender what would you do?

The first step will be to dump any loan forms which allow no doc or low doc mortgage applications. You can’t use them with FHA loans and now you won’t want to use them with residential mortgages in general.

Next, you’re going to tell loan officers that every loan application must be fully verified, with no exceptions. This means some mortgage volume will be lost.

Lastly, as a lender you’re going to look at the new rules and recognize that the game isn’t over. There are still a lot of regulations to be written, a process which will take years.

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