Passage of the Dodd Frank Financial reform Act brought with it a new era of government oversight of the mortgage industry.

Within the Act is a Section titled “Mortgage Reform and Anti-Predatory Lending”.  This segment of the Act focuses on the standardization of data collection for mortgage loans.  It also imposes an obligation on lenders to only originate loans to borrowers who have the ability to repay a standard mortgage  and attempts to limit what the Act considers excessive transaction fees or abusive terms.  However the characteristics of a standard mortgage such as excessive fees, and abusive terms are still not fully defined. 

Next the Act devotes a section to “Minimum Standards for a Mortgage”. Here the Act established the requirement for national underwriting standards for residential loans.  These standards have not been defined.  The Act further states that a standard mortgage will be considered a Qualified Residential Mortgage (QRM).  If the loan can’t be considered a QRM, the originating lender must retain a percentage 5% to 10% ownership of the non QRM pool of loans. 

So how does this relate to underwriting overlays in the loan approval process.  Fannie Mae is considered the industry standard for underwriting guidelines.  When a lender deviates from these standards, it is often called an underwriting overlay.  In today’s mortgage market, lender overlays are actually more restrictive than FNMA guidelines. Why?

Under the Mortgage Reform and Predatory Lending section of the Dodd Frank Financial Reform Act, the following are a few of the still undefined areas:

1.    What definitions will be used as the bench mark of a borrower’s ability to repay a loan? What will be counted as stable income, a borrower’s maximum debt ratio, and minimum credit scores?

2.    What will be a standard mortgage?  Will a 15 yr loan be treated the same as a 30 yr loan, will only fixed rate loans and not adjustable rate loans be considered standard?  Will revisions to the Act require a minimum down payment of 5, 10 or 20 percent?

If a lender has originated a mortgage that is considered a standard mortgage, has adequately determined a borrower’s ability to repay, and has not charged excessive fees, the mortgage will be considered a Qualified Residential Mortgage (QRM) and the lender will have assured themselves of a Safe Harbor.

A Safe Harbor determination will protect the lender from future lawsuits and a defense by borrowers against foreclosure for default on their mortgage.  The designation of a mortgage as a QRM also means that the lender will not have to retain a percentage ownership and all QRM’s will be sellable into the secondary market.

Wrapping it up, lenders know the benefits of originating a Qualified Residential Mortgage.  They just don’t know what the final rule will be, but, whatever it is, they want to have a Safe Harbor from lawsuits and forced retained ownership in loans they originate.  

The Underwriting Overlays are caused by lenders trying to protect themselves from perceived but undefined risks contained in the Dodd Frank Financial Reform Act.

By one law firms count, the Act is categorized into sixteen titles, requires regulators to create 243 rules, conduct 16 studies, and issue 27 periodic reports.  The Act contains 2319 pages which is more than the Obama Care Act.