Qualified Residential Mortgage (QRM) Rule Could Set the Bar at 43% Debt-to-Income

Update: The proposed QRM rule was unveiled on August 28. A 500-page draft of the rule can be found on the FDIC’s website, and also in the documents section of our QRM website.

Another new mortgage rule could be announced by the end of this month, and it could create smaller waves than expected.

The so-called Qualified Residential Mortgage (QRM) is currently being hammered out by a group of six financial regulatory agencies. The new rule, which was mandated by the Dodd-Frank Act of 2010, will require lenders to keep a certain percentage of mortgages on their books.

Loans that meet the definition of a Qualified Residential Mortgage will be exempt from the risk-retention requirement. This gives lenders a powerful incentive for generating QRM loans – they can sell 100% of them into the secondary mortgage market.

A Newer and Softer QRM Rule?

The QRM rule has been a long time coming. It was first proposed early in 2011, but has yet to be finalized or implemented. Earlier proposals included a 20% down-payment requirement and a maximum debt-to-income ratio of 36%. But those proposals drew criticism from a variety of groups, ranging from the National Association of Realtors (NAR) to the Mortgage Bankers Association (MBA), and even a few nonprofit consumer-advocacy groups.

According to a recent Bloomberg report, the current version of the Qualified Residential Mortgage is “softer” than previous proposals. It seems the MBA’s lobbying efforts have paid off. Financial corporations influencing financial regulators. Where have we heard that before?

The details of the forthcoming QRM rule are being finalized by a group of federal agencies that includes the Federal Reserve, the Federal Housing Finance Agency, the Department of Housing and Urban Development, the FDIC, the Securities and Exchange Commission, and the Office of the Comptroller of the Currency.

You might think having so many cooks in the kitchen would make a mess of things. In truth, the Qualified Residential Mortgage rule seems to be getting simpler and more streamlined. Go figure. If the QRM rule was implemented in its earlier proposed form, it would have created a lot of confusion among lenders and borrowers alike. We would have had two similar sounding rules — the Qualified Mortgage (QM) rule was finalized in January — with two different sets of requirements.

QM vs. QRM

But now, it seems the QRM will be closely aligned with the QM rule in one key area. According to sources who asked to remain anonymous, the Qualified Residential Mortgage will focus on the borrower’s debt-to-income ratio, or DTI.

Qualified Residential Mortgage Could Focus on Debt Ratios

Mortgage lenders have long used DTI ratios when considering borrowers for home loans. These ratios give lenders another way to measure risk. Statistically, borrowers with higher debt-to-income ratios are more likely to default on their loans, since they are stretching their paychecks more thinly.

Currently, mortgage lenders have the final say when it comes to debt-to-income ratios and loan approval. But the Qualified Residential Mortgage rule could alter that to some extent. QRM would not only establish clear guidelines and standards for DTI ratios. It would essentially reward lenders for adhering to those standards.

By sticking to the QRM requirements, lenders would be able to sidestep the risk-retention rules mentioned earlier. They would be able to sell more of their loans into the secondary market, reducing their long-term exposure and risk.

The Dodd-Frank Act required regulators to look at “historical loan performance data” when devising the Qualified Residential Mortgage rule. Here’s where it zeroed in on debt ratios, in particular:

QRM and DTI, mentioned in Dodd-Frank
An excerpt from the “Credit Risk Retention” section of the Dodd-Frank Act

According to Bloomberg, two people familiar with the new rule (who asked to remain anonymous) have said the “line” will be drawn at 43% debt-to-income ratio. This means the borrower’s back-end or total DTI must not exceed 43%, if the home loan is to be considered a Qualified Residential Mortgage.

That number should have a familiar ring to industry professionals. Previous rules have also set the DTI bar at 43%. It seems that federal financial regulators aren’t comfortable with debt-to-income ratios above 43%.

Disclaimer: This story contains comments from third-party sources. These sources are deemed reliable but not guaranteed. We should know more about this new rule by the end of August, when additional details are expected to emerge. We will update this story and provide new coverage when those details become available.