A proposed rule that would require a 20 percent down payment for homebuyers to get the lowest mortgage rates is being heavily criticized by many in the industry, who say it would prevent millions of well-qualified borrowers from buying a home.

The rule could raise interest rates by as much as 3 percentage points for homebuyers who can't meet that standard, according to some estimates, while doing little to reduce the risk of mortgage defaults, according to a coalition of industry groups.

Known as the qualified residential mortgage exemption (QRM), the proposed rule is one of the reforms to mortgage and housing markets that Congress has required to prevent a repeat of the subprime mortgage crisis of a few years ago. Basically, it requires that lenders keep a 5 percent stake in any mortgages they write, unless those loans meet specific standards meant to ensure against default.

Intended to prevent defaults

The standards that regulators are proposing include a 20 percent down payment on home purchases, and 25 percent equity for mortgage refinances. Known as "skin in the game," the requirements are intended to make lenders more cautious about whom they lend to.

But that's too strict, say critics, who say the requirement would significantly raise borrowing costs for the vast majority of borrowers who can't meet those standards.

"A 20 percent down payment requirement for the QRM means that even the most creditworthy and diligent first-time homebuyer cannot qualify for the lowest rates and safest products in the market," read a critique of the proposal submitted to Congress by the industry coalition. The group includes the Mortgage Bankers Association, National Association of Realtors, National Association of Home Builders, the Center for Responsible Lending and others.

Would be a hardship for many borrowers

The group argues that such a requirement would only minimally reduce the likelihood that a mortgage will default, while greatly increasing the number of borrowers who would not be able to qualify for the lowest rates.

"This rule hardwires some of the least flexible underwriting standards any of us have ever seen," said Henry Cunningham Jr. a North Carolina mortgage banker and member of the MBA board of directors, in testimony before a House Financial Service subcommittee yesterday. "The hardest hit would be first-time homebuyers, minorities, and middle class families, for whom the down payment requirement would be nearly insurmountable."

He noted that only one-third of all mortgages purchased by Fannie Mae and Freddie Mac would have qualified under the proposed standard in 2009, which he described as "the most cautiously underwritten market in generations."

The coalition contends that a 3 percentage point increase in interest rates - from 5 percent to 8 percent, for example - could prevent 12 million households from becoming homeowners. They say the typical household would need 14 years to save up the 20 percent down payment needed to get the lowest rate.

Published on April 15, 2011