A look at the impact of the US Government's new mortgage rules on wealthy clients.

Last month the US Government rolled out new mortgage rules to essentially prevent borrowers of all stripes from being granted loans they may be unable to repay.

Family Wealth Report spoke to Mike McPartland, head of investment finance at Citi Private Bank, about the ramifications of the new rules on wealthy lenders and borrowers.

The new “Ability-To-Repay” (ATR) rule requires mortgage lenders to verify all details of the client’s financial situation via a third-party, rather than a client merely stating his or her income. The new designation "Qualified Mortgage" (QM) is one that meets the ATR guidelines, where the cost of the loan, plus the client’s entire debt, cannot exceed 43 per cent of their gross annual income.

“As a lender, if you can validate that the loan was underwritten according to QM terms, there is a presumption of innocence from your perspective, should a client claim to have been given a loan they were unable to repay,” Mike McPartland, head of investment finance at Citi Private Bank, told this publication.  Thus, QMs can help protect lenders from lawsuits claiming unfair or deceptive lending practices.

Loans that fall outside this bucket are considered “non-QM” – for example, interest-only and negatively amortizing loans – but are still subject to the ATR rule. In this instance, a range of factors - income, assets, employment status, credit score and debt – have to be documented. 

McPartland explained that, prior to the US housing crisis, lenders often tried to streamline loan approvals for clients by requiring minimal documentation, in an effort to make the process hassle-free. The market was more relaxed with lenders relying on “a lot of judgement” when calculating debt-to-income ratios. Those practices will likely cease as lenders aim to meet QM and ATR requirements.

“In truth, these changes don’t significantly impact our business at Citi Private Bank because the ATR requirements are essentially the operating principles of our business and have been for decades. The way regulators are requiring lenders to analyze mortgage details going forward is very consistent with how we’ve always worked - by assessing a client’s complete financial picture and their overall relationship with us, including their sources of income and other assets,” McPartland said.

Wealthy clients

While the rules won’t impact the high net worth borrower much, or indeed the HNW lender, there are a couple of instances where things might be trickier going forward – one of which involves loans for clients who have a substantial amount of wealth or assets but who do not have “ordinary verifiable cash flow.”

“The reason that becomes more difficult is because the new rules state that lenders must independently verify the client’s ability to repay via a third party,” McPartland said.

“If the client comes from a wealthy family and doesn’t have a steady income - for example, perhaps he or she is living off income from a trust - those things are more difficult to verify,” he said. “Lenders also have to make decisions about how long that money or pool of assets will be available to service the debt of the loan.”

McPartland pointed out that for clients in such situations, where there were previously ten available lenders, “that number has likely been reduced significantly.”

“If you were in this business prior to the new rules taking effect, and would have made a perfunctory decision to lend to a client because they had $20 million in the bank, that's not enough analysis under the new rules.”

McPartland believes the rules will “change the perspective for a number of institutions,” depending on how involved they were in the alternative lending business to begin with, or lending to clients who have unique financial situations.

In fact, it could be advantageous for the private banking industry, he said.  

“To some extent, the regulators are telling banks to stick to their knitting; if you’re a retail bank and you’re used to dealing with clients who have a pay stub, then that is fine. But if you’re a private bank which specializes in working with ultra wealthy borrowers who are often in unique situations, and in analyzing their financial characteristics, then stick to that. Working with these types of borrowers is our core competency.  This is our market and it’s the kind of thing we are used to dealing and working with.”