Regulators Could Ease Lender Rules, Underwriting Guidelines

by Amy Lillard

(7/29/2013) After the financial crisis of 2007-2009, federal regulators sought to create stricter guidelines for mortgage lenders, particularly when it came to mortgage-backed securities. As a result, lenders created tougher rules around mortgage underwriting.

But if recent reports are to be believed, these rules may be changing, and underwriting guidelines may eventually become less strict.

As part of the Dodd-Frank Act in 2010, aimed at Wall Street reform, regulators required lenders and bond issuers to carry a 5 percent stake in the mortgages they include as part of mortgage-based securities, bundled for investors in the secondary market. These securities were at the center of the financial crisis, as the housing bubble burst, bad loans defaulted, and investors lost billions.

Regulators and critics said lenders deliberately packaged subprime loans and highly risky mortgages into these securities, and to stop this problem, instituted the 5% stake rule.

But at the same time, Congress directed six regulators to dictate certain loans—such as traditional 30-year, fixed-rate mortgages—wouldn't be subject to these new rules. According to reports from Reuters and the Wall Street Journal, six U.S. regulators (including the Federal Deposit Insurance Corp and the Federal Reserve) are looking to propose more loans be exempted from these rules.

In 2011, a proposal suggested that loans with at least a 20 percent down payment would be exempted from the 5 percent stake rule. Now, regulators want to change this, and only require banks to keep a 5 percent stake in loans that are “interest-only” or that don’t provide complete documentation of ability to pay. These are the riskiest loan products, and much smaller portion of the market.

Why would regulators consider this? They’re increasingly nervous about the recovery of the housing market. And they’re facing increasing pressure from lenders, consumer groups, and even some legislators, saying the rules are too restrictive and could prevent first-time and lower-income borrowers from purchasing homes. Slowing recovery further.

If regulators do relax the rules, it could lead to less strict underwriting guidelines. If lenders do not feel the pressure of having a stake in mortgages, they may be willing to consider applicants without a 20 percent down payment and provide more reasonable rates and terms. Supporters say this would loosen credit and further the housing recovery. Opponents say this could lead to the same type of irresponsible lending that led to the housing bubble in the first place.

According to reports, regulators could solicit public comment in September, and could finalize their rules by the end of the year. Other agencies involved include the Office of the Comptroller of the Currency, the Securities and Exchange Commission, the Department of Housing and Urban Development, and the Federal Housing Finance Agency.