What are we all to do when a bright line eliminates a gray area?
In the process currently underway to help define a qualified mortgage (QM) for purposes of satisfying provisions of the Dodd-Frank Act, some have proposed using a defined debt-to-income ratio (DTI) of 43 percent as a so-called “bright line” for qualified mortgages.
Loans written with a DTI below 43 percent qualify. Those written for borrowers with a DTI north of 43 percent don’t.
A lender can still choose to write a loan under whatever terms they want, but if it isn’t qualified, it can’t be easily sold on the secondary market – in which case, why make it at all? In recent testimony before the House Subcommittee on Financial Institutions and Consumer Credit, the American Bankers Association acknowledged this, saying the QM standard, once passed, “will become the stage on which most mortgage lending will take place.”
Under the inflexible QM standard that has been proposed, mortgages are homogenized, packaged and sold like eggs in a carton – all of uniform and predictable size and quality.
This inherent predictability has advantages. For lenders, knowing they followed a detailed set of instructions to the letter when writing a loan provides welcome certainty against legal liability and expense.
And there’s something to be said for potential borrowers knowing if they’ll qualify for a mortgage or not well before ever shaking hands with a mortgage officer.
The bright line method is simple. It’s easy to understand.
And it’s disastrous.
Imagine two borrowers, with the exact same income and employment history, applying for the exact same loan amount for properties in the same neighborhood. One has a little more student loan debt than the other, so his DTI comes in at 43.1 percent. The other squeaks in with a DTI of 42.9 percent. Is it fair to deny the former but approve the latter? No. And we imagine that most competent loan originators would approve Mr. 43.1 if given the chance.
But the very nature of bright line QM standards denies them that chance. And if loan underwriters are denied the opportunity to utilize their greatest asset – namely, their ability to parse mortgage applications and spot the subtle things that can spell the difference between approval and non-approval – then why have them at all? Who needs expensive loan underwriters when an iPhone app can fill the same role?
Additionally, shoehorning lenders into complying with a universal, rigid set of rules risks losing the kind of independence and hyper-local focus many community financial institutions rightfully take pride in.
If no one in a given community has a DTI below 43 percent (or 42 percent, or 50 percent… wherever the line gets drawn), does that mean nobody in the community can get a mortgage? Or if a handful of folks can qualify, but the majority can’t, do those in the minority dare do something as ostentatious as buying a home, risking resentment from their community peers, friends and clients?
And what becomes of the community institution that had successfully been making loans in that community for years prior to rule changes?
Supreme Court Justice Stephen Breyer once noted that “no single set of legal rules can ever capture the ever changing complexity of human life.”
That sentiment rings especially true in this debate. Better to have a series of flexible guidelines for qualified mortgage underwriting – applicants are judged on, say, six sets of criteria, and must pass muster on any four for approval – than only one or two hard and fast rules.
This country was founded on flexibility, and boasts an ability to adapt to changes that remains unmatched. We aren’t a nation of absolutes. By our nature, we are a nation that lives squarely in the gray area.
It would be a shame for a few bright lines to ruin that.
