New rules for mortgage rates have just gone into effect and they raise a question: Do the new standards for mortgage rates help or hurt borrowers?
For most mortgage borrowers new interest-rate standards kicked in as of January. The rules are complex but basically they look like this:
First, lenders can make "qualified mortgages" (QM) or mortgages that are not qualified (non-QM). If lenders make non-QM loans they can charge higher rates of interest but they have a lot more legal liability and cannot require prepayment penalties. Given the more than $100 billion recently paid out to settle mortgage-related claims you can bet that most loans will be qualified mortgages.
Second, qualified mortgages include FHA, VA, conventional and some "portfolio" loans. A portfolio loan is financing the lender originates, keeps and does not re-sell on the secondary market. The only portfolio loans that count as qualified mortgages are those that meet certain standards, including the interest rate cap.
Mortgage Rates and the APOR
Third, under Wall Street Reform the basic interest-rate benchmark is called the APOR or Average Prime Offer Rates. There are separate measures for fixed-rate financing and adjustable-rate mortgages.
Notice that the APOR is different from the APR -- the annual percentage rate. The APOR is an official measure used by lenders to develop rates while the APR reflects a wider set of costs paid by the borrower.
Fourth, lenders who make qualified mortgages must originate loans that meet a series of standards. In terms of interest rates for a first lien, if the interest rate is not more than 1.5 percent above the APOR it is assumed that the interest-rate requirement has been met. The standard increases to 3.5 percent above the APOR for subordinate financing such as a second mortgage.
Mortgage Rates and the New Rules
The new rules very much help borrowers -- and lenders.
Before the mortgage meltdown borrowers largely selected financing options from a short list of choices: FHA, VA and conventional financing. These were well-known and well-tested loan products with foreclosure rates that were roughly in the .4 percent range. In other words, if you had 50 million mortgages you could expect that about 200,000 loans would fail each year.
Seen the other way, 99.6 percent of all mortgages performed. This was very enticing to mortgage investors worldwide and they were happy to put cash into the US mortgage marketplace. With a solid supply of cash it was possible to hold down interest rates.
The mortgage meltdown was caused in large part by the introduction -- and failure -- of high-risk mortgage products. Wall Street Reform is an effort to reduce risk in the mortgage marketplace by saying to lenders, "hey, if you make low-risk qualified mortgages you'll make money, few borrowers will lose their homes and -- oh yes -- it will be virtually impossible for you to be sued."
In addition to interest rates, points and fees are also capped at 3 percent of the principal amount for most loans of $100,000 or more. Balloon loans, interest-only products, no-doc loans and option-ARMs are outside the qualified mortgage definition and thus will not be offered by most lenders.
The end result is that borrowers have an incentive to shop for the best available rates and terms, lenders have very good reasons to make such loans, and investors have real reasons to put cash into US mortgages. It's a win-win-win for everyone who benefits from low-cost mortgage financing.