Dodd-Frank Rules Make Mortgages Less Profitable: One Year Later

Mortgage lender Mike McHugh has already had to license his loan originators, change the way they’re paid, and adopt new underwriting standards -- steps needed to comply with new rules and realities in the wake of the collapse of the housing bubble.

It’s not over yet. McHugh, president and chief executive officer of Continental Home Loans Inc. in Melville, New York, is about to endure even more change as the Dodd-Frank Act, designed to prevent another mortgage-fueled frenzy like the one that led to the 2008 credit crisis, kicks in this summer.

“The rules have been changed so many times,” McHugh said. “If you’re not on top of all the issues it’s very, very difficult to stay in business today.”

Lots of changes that have already taken place in the almost $11 trillion U.S. mortgage market have nothing to do with Dodd-Frank. Government-backed mortgage securitizers Fannie Mae and Freddie Mac have raised underwriting standards, the Federal Housing Administration more than doubled its fees, and many banks remain reluctant to lend at all. Even without the new law, mortgages are more expensive and harder to get.

Still, Dodd-Frank, which marks its one-year anniversary on July 21, is expected to take those changes a few steps farther. The new rules are designed to tighten additional weaknesses in the mortgage system that contributed to the crisis, including no-downpayment loans, the “originate-to-distribute” business model, and mortgages with confusing terms and deceptively low teaser rates.

Risk Retention

For mortgage originators like McHugh, the most notable Dodd-Frank provision is a risk retention measure that would require most lenders and investors to keep a 5 percent stake in loans they bundle or sell. For McHugh, the outcome could mean life or death for his business.

“We don’t make 5 percent on a loan. To put 5 percent up on risk retention would put us out of business,” he said.

The rule is being drafted by six banking and housing agencies including the Federal Reserve, Federal Deposit Insurance Corporation and Department of Housing and Urban Development and numbers more than 350 pages. It was designed to make sure that mortgage originators don’t just pass loans on to others; they must retain a financial stake in the mortgage.

Larger Downpayments

The risk retention rule could also affect homebuyers by requiring them to keep their own “skin in the game” with a 20 percent downpayment on a house in order to get the cheapest loan. The housing boom and the cheap and easy credit that fueled it made big downpayments rare. Today, many buyers expect to get a loan with 10 percent down or less.

More than 40 housing, financial and consumer groups have aligned to fight the plan, saying it would restrict lending and discriminate against low- and moderate-income buyers. The proposal also threatens the $759 billion mortgage insurance market, which sells policies on loans with small downpayments. Regulators are unconvinced that mortgage insurance reduces the risk of default and have told the industry to make its case.

Nearly 300 members of Congress have criticized the risk retention proposal. On June 7, regulators extended comment on the rule from to Aug. 1, effectively delaying implementation. After that, regulators will work on revising the draft plan.

“This is one area where Congress may take another look. There could be some fine tuning,” said financial services lawyer Richard J. Andreano Jr., a partner at Patton Boggs LLP in Washington.

Shopping Sheet

Perhaps the biggest change for mortgage shoppers is a new form that will make it easier to decipher fees and rates and comparison shop for deals. The forms are one component of a set of new consumer-protection rules on mortgages required by Dodd-Frank.

In May, the Consumer Financial Protection Bureau released two versions of the new “shopping sheet,” and asked for public feedback. It got over 13,000 comments on the first two model disclosure forms it released, and is now analyzing the feedback, according to the agency’s website. The bureau -- which officially starts work on July 21 -- will oversee many of Dodd-Frank’s new consumer protections.

“These forms were a huge move forward,” said Deborah Bosley, an associate professor of English at the University of North Carolina in Charlotte who studies how to simplify language. “Much of the information is much, much clearer.”

For banks, the forms herald changes that could give an advantage to smaller lenders.

More Competition

Elizabeth Warren, the Obama administration adviser setting up the consumer bureau, has touted disclosure simplification as a way for smaller community banks to better compete against financial giants such as Wells Fargo & Co. and JPMorgan Chase & Co. Wall Street banks can be more adept at hiding costs, Warren says, so with better disclosure, consumers will rely more on intangible factors such as their personal relationship with a bank.

Jerry Little, president of the New Hampshire Bankers Association, said the forms appear to be an improvement although community bankers remain concerned about the regulatory burden.

“The real cost of compliance is not the form in front of consumers, it’s the internal paperwork involved in proving to the next examiner that you’re doing the mortgage properly,” Little said in an interview.

The law will also protect homebuyers with anti-predatory lending rules that ban banks and originators from steering borrowers to more-expensive loans. Lenders also will be required to verify a borrower’s income and debt.

The consumer bureau must propose the new regulations by July 21, 2012.

While McHugh prepares, he worries he could expose his company to litigation if he makes a mistake. Ultimately, Dodd-Frank will make home loans more expensive and “erode the buying power of the American homebuyer,” he said.

For now, “the biggest change has been the unknown. It creates a lot of extra anxiety.”