Clem Ziroli Jr.’s mortgage firm, which has seen its costs soar to comply with new regulations, used to make about three loans a day. This year Ziroli said he’s lucky if one gets done.
His First Mortgage Corp., which mostly loans to borrowers with lower FICO credit scores and thick, complicated files, must devote triple the time to ensure paperwork conforms to rules created after the housing crash. To ease the burden, Ziroli hired three executives a few months ago to also focus on lending to safe borrowers with simpler applications.
“The biggest thing people are suffering from is the cost to manufacture a loan,” said Ziroli, president of the Ontario, California-based firm and a 22-year industry veteran. “If you have a high credit score, it’s easier. For deserving borrowers with lower scores, the cost for mistakes is prohibitive and is causing lenders to not want to make those loans.”
Federal regulations, enacted after the collapse of the subprime market spurred the financial crisis, are boosting mortgage costs this year. Most lenders are responding by providing home loans only to borrowers with near perfect credit, shutting out creditworthy Americans whose loan files are too expensive to review and complete. If banks commit compliance errors in issuing a loan that goes bad, they have to buy it back at a loss from Fannie Mae or Freddie Mac.
During the housing boom between 2004 and 2007, lenders provided about $2 trillion in subprime loans, many to unqualified borrowers. So-called liar loans didn’t require borrowers to provide pay stubs or tax returns to document earnings. Teaser rates as low as 1 percent offered on mortgages soared when they reset a few years later.
The share of subprime mortgages for which borrowers either provided little documentation of their assets or none at all rose to 38 percent in 2007 from 32 percent in 2003, according to a paper published by the Federal Reserve. Almost one in four of those mortgages defaulted by 2008 compared with one in five of fully documented subprime loans. Wall Street firms securitized pools of the loans called collateralized debt obligations and sold them to investors. They also created so-called synthetic CDOs that were derivative instruments designed to mirror the performance of the loan pools.
“What started the crisis were these loans that were designed to fail, loans that weren’t underwritten at all,” said Julia Gordon, director of housing finance and policy at the Washington-based Center for American Progress, which has ties to the Democratic Party. “No one quite realized that these loans were then at the bottom of this giant pyramid scheme, where the Wall Street derivative products that were based off of them would just come crashing down and take the whole economy with them.”
Federal rules put in place after the 2008 financial crisis attempt to prevent such reckless lending. The Consumer Financial Protection Bureau in January began implementing the qualified mortgage rule, a 52-page document mandating that lenders must take detailed steps to prove that borrowers have the ability to repay their mortgages. The measure also cracks down on risky loan features such as balloon payments and large fees by leaving lenders exposed to legal liability if they issue such loans.
“The industry as a whole did a terrible job of self-policing and they should not be shocked that there’s now more oversight than there was before,” Gordon said.
The CFPB has issued eight rules since 2011 governing everything from appraisals to compensation for loan officers. Six regulators including the Federal Reserve jointly issued a 553-page document this week containing instructions for when lenders must retain a stake in mortgages that they package for sale to investors. And the industry is now bracing for sweeping regulatory changes from the CFPB that take effect in August governing the mortgage estimates lenders give borrowers.
Bill Cosgrove, chief executive officer of Strongsville, Ohio-based Union Home Mortgage Corp., said the issue for lenders isn’t more regulation. In a speech earlier this week to attendees at the Mortgage Bankers Association annual conference in Las Vegas, Cosgrove said the several regulatory agencies are not coordinating efforts and are producing overlapping and conflicting rules.
“The regulatory avalanche of today’s Washington isn’t working and we are seeing the results in today’s marketplace,” he said. “Regulators who oversee the mortgage market aren’t coordinating, and it’s driving up the cost of homeownership. Or worse, taking homeownership out of reach for too many Americans.”
Lenders’ expenses to make a single loan averaged a total of $6,932 in the second quarter, a 35 percent jump from two years ago, when average volume was similar, according to the MBA. The cost reached $8,025 in the first quarter.
The higher costs and concerns about buybacks are driving the decline in mortgages for home purchases. It will slow to $635 billion this year, a 13 percent drop from 2013, according to MBA estimates.
Banks have constrained home lending to many borrowers deemed creditworthy by mortgage finance companies Fannie Mae and Freddie Mac. Applicants approved for mortgages to purchase homes had an average FICO credit score of 755 in August, according to Ellie Mae, a company that makes software used to process mortgage applications. In contrast, Fannie Mae and Freddie Mac guidelines allow for credit scores as low as 620 for fixed-rate mortgages in some cases.
Lenders reported a 30 percent median increase in compliance costs this year from 2013, according to a survey by Fannie Mae released this month. And 72 percent of lenders surveyed said they spent more on compliance this year compared with last year.
Banks are passing some of the costs of compliance to borrowers. Initial fees and charges paid by consumers on agency fixed-rate purchase loans have increased 10 percent to 1.21 percent as of August compared with a year earlier, according to survey data from the Federal Housing Finance Agency. The fees reached a high of 1.35 percent in February this year.
Smaller lenders may be hurt the most by compliance costs, said Guy Cecala, publisher of Inside Mortgage Finance, a trade publication. They have fewer resources to maintain records and train employees, which is essential to protecting lenders in the new regulatory environment, he said.
“There’s no question in this newer market it’s harder for smaller lenders to survive,” Cecala said.
These lenders, which have smaller balance sheets, generally can’t hold the loans on their books and have to sell them to government agencies or investors. At 1st Priority Mortgage, based outside of Buffalo, New York, one investor who buys the company’s loans requires employees to fill out a seven-page form verifying compliance with qualified mortgage standards. Other investors each require different forms, said 1st Priority’s President Brooke Anderson Tompkins.
The costs of satisfying investors, on top of the reams of paperwork, intensified staff training and software upgrades to please regulators, are eating into the company’s margins at the same time that volumes are down, Anderson Tompkins said.
“Our costs have gone up significantly, because from our perspective, we don’t have a choice but to comply,” she said. “You miss one of those boxes” on the form “and you potentially have a loan that is not ever saleable.”
Some of the burden of the additional costs will eventually ease with familiarity and automation of processing, said Gordon of the Center for American Progress. The CFPB provides some relief for lenders with less than $2 billion in assets and fewer than 500 purchase originations or refinancings a year. The agency waives the 43 percent cap on the debt-to-income ratio that’s part of the qualified mortgage rule for larger banks.
Regulators are also reducing buyback risks to lenders. U.S. Housing and Urban Development Secretary Julian Castro, who oversees the Federal Housing Administration, pledged at the MBA conference to help give lenders more certainty about when they would face liability for defaults on loans. Federal Housing Finance Agency Director Melvin L. Watt also provided details on what will trigger penalties for lenders who sell loans to Fannie Mae and Freddie Mac. More specifics will be unveiled in the coming weeks.
The largest lenders won’t pull back substantially from the market even as costs rise because they want to maintain relationships with customers to cross-sell products, said Kevin Barker, an analyst at Compass Point Research & Trading LLC. They also get revenue from other business units to withstand the mortgage costs for longer than smaller lenders, Barker said.
Ziroli of First Mortgage said he hired several examiners to be another set of eyes and review non-credit related items in loan files, such as missing documents.
“All government agencies are insistent on this perfect file,” he said. “As you go down the FICO grid, there’s a higher probability of a mistake.”