Sunday, July 11, 2010

MORTGAGE & FINANCE: The return of the plain vanilla mortgage

Plain vanilla is back, in stealth mode.

A year ago, the Obama administration set out its goals for financial reform. One goal was to require mortgage lenders to offer "plain vanilla" loans. The definition of "plain vanilla" wasn't as narrow as you might expect: It included not only 30-year fixed-rate mortgages, but also hybrid ARMs. A plain vanilla mortgage would fully amortize in 30 years or less, and be fully documented, and have a reasonable rate and fees.

The Senate tossed out plain vanilla quickly. But a form of plain vanilla survives. The financial regulation bill that emerged from the House-Senate conference doesn't require lenders to offer plain vanilla mortgages, but it offers strong incentives.

The main incentive involves "risk retention." Under the compromise bill, the lender and possibly the securitizer would have to keep 5 percent of each mortgage when it is securitized. This requirement would remove some of the benefit of securitization. By tying up banks' reserves, the risk retention requirement would reduce banks' ability to lend.

But plain vanilla loans are exempt from the risk retention requirement. The bill doesn't call these loans "plain vanilla" -- it calls them "qualified residential mortgages."

Ultimately, I think the big banks will stick with plain vanilla loans. If subprime or interest-only or option ARM mortgages ever make a comeback, they might come from residential investment real estate trusts that will have powerful incentives to lend prudently. And many of those loans are likely to share the appreciation between borrower and lender.

For example, an option-ARM lender might require a sizable down payment, and the lender might also get the first 5 percent of price appreciation when the house is sold or the loan is refinanced. And the lender might get a split of the appreciation after that.

Yep, that's where I think this is going: When a lender has to retain 5 percent of the risk, it's going to want a share of the house's appreciated value.

Most borrowers will just want a plain vanilla. And if you got this far, I bet you can't believe you just read a 354-word piece on qualified mortgages and shared appreciation, you policy wonk you.

By Holden Lewis · June 29, 2010

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