20% down payment gets its day in courts as regulators push to lessen risk

Source: Wall Street Journal

Banking regulators are pushing for mortgage-lending rules that require homeowners to make minimum 20% down payments on loans classified as lower-risk, according to people familiar with the matter.

The proposal is being floated as a way to rewrite the rules for mortgage lending to prevent a rerun of the housing bubble and financial crisis that resulted from years of easy credit. The Dodd-Frank financial overhaul law enacted last year enabled regulators to define a so-called gold-standard residential mortgage that would be exempt from costly new rules.

At least three agencies—the Federal Reserve, the Federal Deposit Insurance Corp. and the Office of the Comptroller of the Currency—back a proposal to require home buyers to put down at least 20% of the sales price in order to obtain one of these "qualified residential mortgages." One proposal would also require borrowers to maintain a 75% loan-to-value ratio for refinances, and a 70% loan-to-value for cash-out refinances in which the borrower refinances into a larger loan, according to people familiar with the matter.

Mortgage-finance giants Fannie Mae and Freddie Mac would also be exempt from the rules while they remain in conservatorship, according to these people. The U.S. took over the firms in 2008, and the Obama administration has proposed eventually winding them down.

The behind-the-scenes debate over the proposal could have far-reaching implications for how Americans finance loans, because it addresses how much equity new borrowers should have in their homes.

It is unclear whether the proposal will garner support among other regulators and be acceptable to the White House and Congress. Altogether, six federal agencies—the three supporting the proposal plus the Department of Housing and Urban Development, the Federal Housing Finance Agency and the Securities and Exchange Commission—must sign off on the proposal before it is released for public comment. It could not be determined Tuesday whether all the agencies would support the 20% down-payment standard.

At a congressional hearing Tuesday, HUD Secretary Shaun Donovan said no deal has been reached yet, and that any plan could instead spell out options.

At a separate hearing Tuesday, Treasury Secretary Timothy Geithner said, "We've got to be careful that we get it right." He added, "I'm not sure how much longer it's going to take, but it's going to take a bit longer than we initially expected."

Meanwhile, some lawmakers expressed concerns that the new rules might make it too hard for homeowners to qualify for less risky, and less costly, loans.

Sen. Kay Hagan (D., N.C.) told Federal Reserve Chairman Ben Bernanke that several lawmakers "are really concerned about not making it so restrictive that we can't have as many well-qualified loans as possible."

The proposal was crafted in response to a provision in Dodd-Frank that aimed to improve mortgage-lending standards. Loans that don't meet the standards for "qualified residential mortgages" and are sold to investors as securities will be subject to a "risk retention" rule, which could raise borrowing costs for homeowners.

The risk-retention rule requires banks to keep 5% of the value of all mortgages they securitize on their books. During the housing boom, many lenders passed on all of their mortgages, and all of the risk, to investors. It was designed to force lenders to have "skin in the game" when selling groups ofmortgages packaged as securities.

Critics of the risk-retention rule said it could raise costs for traditionally safer lending products such as long-term, fixed-rate loans with full income documentation. A coalition of consumer advocacy groups and the real-estate industry have warned that defining the rule too narrowly could raise borrowing costs for millions of creditworthy borrowers.

Regulators must issue a rule defining "qualified residential mortgages" by April, and had initially planned to publish a draft proposal late last year. But the process has been delayed by a disagreement about whether to include in the rule national standards for loan servicers, such as how to modify loans for troubled borrowers. The new proposal reflects a compromise among the regulators to include some standards for how and when banks modify loans.

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