Ability-to-repay proposal undermines mortgage origination advances

Considering the state of flux of the economy, jobs in particular, it’s hard to find succinct wisdom in the Federal Reserve‘s proposal to modify mortgage origination under Regulation Z. In fact, it’s hard to believe it will have a meaningful impact on mortgage originations, though the Fed obviously sees it the other way around. The most glaring flaw with the whole concept is that the ability-to-repay proposal doesn’t achieve anything not already happening in the mortgage origination market. In fact, if anything, it takes a step backward. The amendment, for one, would make sense only if a borrower’s profile is not going to greatly change over the life a 30-year loan. Many modern Americans are unlikely to stay put in one place for three years much less three decades without some key aspect of their lives changing. An ability-to-repay does not protect a borrower from sudden unemployment and subsequent mortgage modification or, worse, foreclosure. The proposal also relies on lenders repeating the underwriting mistakes of the past — an instant disqualification for the secondary market — and not even a reality today. What the regulation fails to address is that underwriting instead should be modified to reflect real time changes, in a way that is constantly updated. Reg Z does not prevent homeowners from getting approval for a mortgage and then immediately taking on too much additional debt, be it car loans, credit cards, etc. There are several vendors who already offer services that project a borrower’s ability to repay. Equifax‘s Undisclosed Debt Monitoring, for one, immediately comes to mind. Lenders can, and will, elect to use these services in order to avoid writing bad loans. Advances such as these will make the largest impact in preventing foreclosures going forward. However, any positive statistical developments will likely be jumped on by the Federal Reserve, which will look to credit these changes to Reg Z as the primary reason for decreased delinquencies. But the Fed rule, to be clear, remains a largely ornamental change. The Fed wants lenders to be sure that borrowers can repay their debts. The central bank is creating a rule and will enforce it. However, the rule disregards some amazing advances in the tech sector that largely trumps this risk. Today, the use of income verification and updated FICO scores is only the first step in underwriting. Yet, the new Reg Z can be satisfied with these simple steps. But it falls woefully short of mortgage lenders current underwriting standards. As a benefit, the new Reg Z will help with refinancing of poorly structured mortgages into safer products. A creditor can refinance a “nonstandard mortgage” with risky features into a more stable “standard mortgage” with a lower monthly payment, according to the Fed. Does this mean, as mortgage modification numbers continue to grow, the Fed will be able to take credit for that as well? Write to Jacob Gaffney. Follow him on Twitter @JacobGaffney.