Even as federal regulators recently cracked down on loose mortgage lending, they hoped that credit unions and community banks would serve as a haven for marginal borrowers.
Such neighborhood institutions know their customers, the theory goes, so they could better judge the risk in lending outside new rules for a so-called qualified mortgage.
But smaller lenders are pushing back, saying they'll just scale back their mortgage business instead. They fear that lending at the margins will make them targets for bank regulators and plaintiffs' attorneys in cases of default.
The new rules come from the Consumer Financial Protection Bureau, created in response to the financial crisis. They aim primarily to ensure that banks verify borrowers' ability to pay and to eliminate the lending abuses that caused the financial crisis of 2008.
"We absolutely believe in protecting the consumer. The CFPB has just gone too far," said Diana J. Dykstra, president and chief executive of the California & Nevada Credit Union Leagues.
That's a problem for the consumer bureau's director, Richard Cordray, who has described his challenge as trying to rein in the lax lending standards without making it too hard for borrowers to access credit.
In the wake of the mortgage meltdown, skittish banks — which have paid billions in legal settlements and loan buybacks forced by regulators — have tightened credit even for well-qualified borrowers, slowing the economic recovery.
So the qualified-mortgage designation, announced in January, had two goals: to keep the banks in line and to give them the regulatory clarity they need to ramp up lending again while protecting them from lawsuits.
Cordray has pointed out that community lenders didn't cause the mortgage meltdown and praised them for making good loans. Such smaller institutions often hold mortgages on their own books, rather than selling the debts to investors or the government-sponsored mortgage giants Fannie Mae and Freddie Mac.
Cordray has urged them to carry on as usual, even if the loans don't always conform to the qualified-mortgage rules.
"The current mortgage market is so tight that lenders are leaving good money on the table by not lending to low-risk applicants," Cordray told a national credit union group in February.
But the local institutions fear that the consumer bureau's qualified-mortgage rules will make any loan outside that box a de facto "subprime loan" — a term that's become an epithet since subprime mortgage investments nearly brought down Wall Street in 2008.
They worry in particular about lending to consumers with debt-to-income ratios higher than 43%, the new standard for a qualified mortgage.
Rodney K. Brown, president and CEO of the California Bankers Assn., said his members worry less about scrutiny from Cordray than from federal bank examiners who may criticize non-qualified loans as too risky. They also fear plaintiffs' attorneys who might accuse banks of making unaffordable loans when mortgages default.
"California, as we view it, is quite a litigious state," Brown said.
The consumer bureau is charged with implementing mortgage regulations under the voluminous Dodd-Frank package of financial reform laws, approved by Congress in reaction to the crisis.
Qualified mortgages generally can't include interest-only payments, negative amortization, balloon payments or terms of more than 30 years. "No doc" underwriting is prohibited, banishing the "liar loans" that allowed borrowers to fabricate their income and were blamed for so many foreclosures. Prepaid interest and fees are generally limited to 3% of the loan amount.
Most important, Dodd-Frank requires lenders to determine a borrower's ability to repay a home loan before writing any mortgage — qualified or not.
The consumer bureau's rules, effective at the end of this year, say qualified mortgages are presumed to be safe and sound. That protects lenders against lawsuits alleging that they overloaded borrowers with debt if the loan defaults.
Community bankers worry that could make it easier for regulators and borrowers — or their lawyers — to blame the bank for defaults on nonqualified loans.
Certain adjustments already have been made to the qualified-mortgage rules. Some small lenders in rural counties, for instance, persuaded the consumer bureau to allow them to continue making home loans with balloon payments, or single large payments at the end of the mortgage.
Rep. Shelley Moore Capito (R-W.Va.), who chairs a House subcommittee on banks and consumer credit, said that hasn't persuaded bankers in her largely rural state to give the nonqualified mortgage their full support.
"I fear — and I've heard this anecdotally — that this approach of 'Washington knows best' will harm the very people the rule seeks to help: borrowers who are on the fringe of lacking access to mainstream financial services," Capito said.
Dykstra, the CEO of the California & Nevada Credit Union Leagues, said more affluent borrowers could also be among those excluded. A borrower earning $10,000 or $15,000 a month, with no non-housing debts, might have troubled getting a mortgage if his house payment, plus taxes and fire insurance, totaled 45% of his gross income, she said.
Perhaps the biggest problem is that government-sponsored Fannie Mae and Freddie Mac won't buy non-qualified loans, Dykstra said.
Credit unions frequently keep mortgages in their own portfolios. But they also need the flexibility to sell them later, she said, so they don't wind up stuck like the savings and loans that drowned in losses on low-earning mortgages when inflation kicked in during the 1970s and 1980s.
"The S&Ls imploded from all those loans on their balance sheets," Dykstra said. "This is going to force us to write nothing but qualified loans, so we have the ability to sell them in the secondary market."