NEW YORK (TheStreet) -- The mortgage industry is in for several changes in 2014, with new rules going into effect, interest rates poised to move higher and a new head at the Federal Housing Finance Agency, regulator of bailed-out housing finance giants Fannie Mae (FNMA) and Freddie Mac (FMCC).
The outlook for mortgage credit, therefore, is rather cloudy. On the one hand, banks might take time to adjust to the new rules, which could curtail credit.
On the other, clarity around new rules and a broad push by Washington to ease access to credit for more borrowers could lead to some loosening in mortgage lending standards.
Beginning this year, lenders will be prohibited from extending mortgages to borrowers who cannot afford a mortgage under the Consumer Financial Protection Bureau's new ability-to-pay rules.Abusive lending practices that were widely prevalent in the boom days such as negative amortization loans and mortgages with a term greater than 30 years would be effectively banned. Banks will instead receive greater protection if they make so-called qualified mortgages, which, among other things, limit the amount of debt a borrower can assume to 43% of his income. And there could be more rules that force banks to retain a certain amount of the mortgages they originate on their balance sheet in order to rein in risky lending practices. Still, while there have been fears that the new rules would severely curtail credit -- by some estimates, about half of the mortgage market could be eliminated in the long run -- the impact of these rules in the near term is relatively benign. For one, mortgage credit conditions are already so tight that the new rules might not have much more of an adverse effect. On the contrary, certainty about the rules might allow lenders to take on some risk and loosen credit. According to Sterne Agee analyst Jay McCanless, mortgage originators have been underwriting to tighter standards than the upcoming rules. "As of November, the average debt-to-income (DTI) ratio for completed conforming mortgages was 41% versus the 43% mandated by the CFPB's [qualified mortgage rule]," he wrote in a note. "We cannot quantify the possible demand increase if the average DTI rises to 43%, but qualitatively, we anticipate implementation and a live evaluation of the rules may widen mortgage availability as originators learn the boundaries of the new strictures." In any case, mortgages sold to the government-sponsored enterprises or GSEs, Fannie Mae and Freddie Mac, and loans backed by the Federal Housing Administration are exempt from the qualified mortgage rule. Banks will likely continue to originate and sell loans that conform to the GSE's and FHA standards. There are other factors that could determine when banks start to extend mortgages more aggressively again. "Investors should pay attention to new initiatives by incoming FHFA director Mel Watt, actions by the CFPB to loosen credit, and calls from the current Administration to extend credit to low-income borrowers," according to a report by FBR Capital's lead analyst Paul Miller. The appointment of Mel Watt (D., NC) to head the FHFA would greatly improve mortgage credit availability, according to FBR. Watt is expected to be significantly different from current acting director Edward DeMarco, who has been more focused on reducing the GSE's footprint and reducing taxpayer exposure to mortgage risks. Watt, instead, is expected to be more aligned with the Obama administration's goals and is likely to direct Fannie and Freddie to do more to support the mortgage market. Already, even before being formally sworn in on Jan.6, he has said he would delay recent proposals to increase the guarantee fee on loans purchased by the GSEs. Analysts expect that other proposals by DeMarco such as one to lower the size of single-family loans purchased by Fannie and Freddie and another controversial proposal to reduce the volume of multifamily loans by 10%, would also face similar delays or be abandoned altogether. Another factor that could help loosen credit is declining repurchase risk. In the last several years since the housing bust, banks have been forced to repurchase many poorly underwritten loans that were sold to the GSEs and private investors during the boom days. Fannie and Freddie have been particularly aggressive in their repurchase claims. However, the FHFA has expressed a desire to finish all repurchase claims stemming from crisis-era loans by the end of 2013. With repurchase claims in the rear-view mirror, banks will have one less threat to worry about, although they continue to face considerable mortgage-related litigation risk. The sooner banks can resolve their mortgage-related legal problems, the easier it would be to focus on new rules and begin making more loans. Finally, the mortgage industry itself has an incentive to start competing for mortgage purchase applications. Refinancing volumes which have propped up mortgage banking in recent years have plummeted as rates have risen from their lows. Purchase applications will not offset the decline in refinancing, but banks will step up efforts to lend to creditworthy borrowers. While it is too early to definitively say that credit will loosen in 2014, the clouds appear to be finally parting for those seeking a mortgage.
-- Written by Shanthi Bharatwaj in New York.