Good news: The U.S. housing industry is on the rebound. In 2013, new home and existing sales were as high as they were in 2006, before the recent recession. As a result, inventory dropped and home prices spiked 12% this year.
While this is a healthy sign for mortgage companies, the net cost to originate loans is increasing. Over a two-year period, for instance, the cost of purchasing loans is projected to increase by 19%.
What's more, The Consumer Financial Protection Bureau's (CFPB) new Qualified Mortgage (QM) and Ability to Repay (ATR) rules are forcing lenders to improve underwriting accuracy, thoroughness, and compliance or suffer the consequences with increased fines.
The Impact of New Compliance Considerations
In light of new Dodd-Frank regulations, loans must now be underwritten and verified with the following "ability to repay" information:
1. Current income, reasonably expected income, or assets held by the borrower.
3. Credit history.
4. Additional debt obligations, such as other loans, alimony, and child support.
5. Monthly payments of additional loans associated with the property.
6. Monthly payments for mortgage-related obligations, including taxes and insurance.
7. Monthly debt-to-income ratio.
Some of this information can be verified through reliable third-party sources, such as credit bureaus. But lenders are now responsible for verifying and maintaining compliance up to three years after loan origination, as well as recording any actions taken on the loan for one year after it's discharged.
Furthermore, the CFPB now qualifies mortgages as follows:
Substantially equal periodic payments, subject to interest rate adjustments.
Is not a negative amortizing mortgage.
Does not defer principal.
Does not have a balloon payment, wherein the remaining principal is repaid at the end of the loan period.
Fees do not exceed 3% of the total loan amount above $100,000.
Loan term does not exceed 30 years.
Underwriting is based on the maximum interest rate during the first five years.
Is based on verified current or reasonably expected income or assets and current debt obligations, alimony and child support.
Monthly debt to income ratio must not exceed 43%.
And there are new safe harbor rules to consider. For example, QM loans will have safe harbor provided they meet the QM and ATR guidelines and non-QM loans will need to meet ATR guidelines to receive a rebuttable presumption. As such, banks are concerned about the additional documentation required to overcome safe harbor challenges. Consequently, the number of new mortgage lenders is expected to slow.
In light of these new regulations, loan volume will undoubtedly decline, as will the number of qualified borrowers due to stricter debt-to-income ratios.
But there is a silver lining: Lending risk will decrease by more than 90%. And small banks and credit unions can still issue on debt-to-income ratios above 43%, provided they keep the loan in-house.
Of course, there are other challenges lenders will need to overcome to thrive amid these new regulations and avoid stiff penalties for violating them. But in our view, offense is the best defense.
Taking the Offensive
In addition to reducing the risk of default, new CFPB regulations are motivating lenders to work smarter. More specifically, accepting lenders are rethinking their processes, rewiring their technology, and reinventing their reporting to ensure repeatable compliance.
To accomplish this, senior lending executives are forming committees to create hassle-free compliance programs improve work streams and set realistic timelines. They're also revising business practices, updating policies and procedures, and upgrading or decommissioning legacy systems to improve underwriting and compliance measures.
Despite such plans, lending organizations still face additional servicing costs and legal exposure. For instance, the cost to service and manage documentation increases the processing cost of loans that qualify for safe harbor. As such, lending companies need a thorough understanding of QM and ATR criteria to properly satisfy each, and they must strengthen underwriting standards for both qualifying and non-qualifying mortgages.
In addition to implementing the requirements, lenders will need to review their compensation structures for loans, revamp document handling systems, and deploy real-time reporting to comply with loan status, resale rights, loss mitigation paperwork, and modification agreements, to name a few.
Thanks to new QM and ATR regulations, however, lending rules are more clearly defined now, enabling the market to better act upon those guidelines with automated processes to determine loan repayments.
Under the new rules, lenders are not only expected to document compliance, but they are urged to implement efficient processes, technology infrastructure, and reporting frameworks to ensure compliance. Again, the tracking and preservation of documents is critical, as new regulations require documentation storage for three years after origination.
With a robust automated system, however, lenders can mitigate non-compliance risks, significant legal costs, interruption of loan origination activities, and increased scrutiny by regulatory authorities.
For instance, loan application data can be processed through a loan origination decision model, which would assess compliance with existing underwriting guidelines. This process could be implemented using the organization's proprietary capabilities or by leveraging outside solutions. Such an assessment can be conducted both for ATR and QM instruments using a pay-per-use model. Doing so provides true transparency into critical decisions and risk, as well as improved borrower communication, participation of key stakeholders, and collaboration.
Automation also provides substantial competitive differentiation. Since the mortgage process is often stressful and one of the more complex transactions a consumer will ever undertake, even minor improvements to the experience will win business. When armed with an automated system, lenders will also gain bid data insights into borrower behavior and credit triggers, including borrower activity and public records. Such insights not only help lenders reduce costs, but they also lead to an improved customer experience.
Ultimately, mortgage automation provides advance understanding of each borrower's ability to qualify for and repay a mortgage. This enables both the underwriter and customer to quickly address any obstacles or documentation conditions in a timely manner. In other words, an automated underwriting process ensures more closed and funded loans. A win for lenders... A win for borrowers.
Most mortgage companies see new compliance regulations as daunting, time-consuming, and expensive, including the associated IT costs needed to improve accuracy and consistency. It's a tough pill to swallow.
But "the pill" can also improve the long-term health of participating lenders. By transitioning to new compliance processes with embedded rules and policies, lenders can perform an automated analysis of captured data, fast track their decision-making, and quickly respond to ongoing regulatory reforms.