On January 10, 2014, new rules issued by the Consumer Finance Protection Bureau (CFPB) take effect regarding home mortgages. The intent is to discourage a repeat of the housing bubble caused by the subprime mortgage crisis.
The new rules are a form of tradeoff: Lenders have greater responsibility to verify that borrowers are able to repay their loan; but, providing the loans meet specific criteria, the lender is partially protected against lawsuits if the borrower defaults. Together, these are known as Ability-to-Repay (ATR) and the Qualified Mortgage (QM) rule.
With respect to ATR, lenders must document and verify information on eight underwriting factors to assess your repayment capability:
- Assets and Income – Includes your assets, current income, and/or reasonably expected future income.
- Employment – Your updated employment status.
- Transaction Payments – The monthly payment on your anticipated mortgage.
- Simultaneous Loans – The monthly payment on any concurrent loan you hold.
- Other Mortgage Expenses – The monthly payment on other mortgage-related expenses such as insurance and property taxes.
- Total Debt – All of your current debts, including running debts such as child support or alimony.
- Debt Ratio – Your monthly debt-to-income (DTI) ratio. In general, your debt needs to be less than 43% of your total gross (pre-tax) income to qualify for a home loan.
- Credit History – Your track record of repaying credit cards and other financed debt.
Lenders have already become more restrictive in the wake of the recent housing crash, but these rules continue the trend toward tougher loan qualification standards. For example, if a loan is adjustable, lenders are now expected to verify borrowers can pay at a fully indexed rate and project 5 years ahead using the highest potential rate to verify the ability to stay under the 43% threshold. Banks and credit unions are still able to make riskier loans, but have limited incentive to do so.
Who is likely to be most affected by these rules? The self-employed, with unpredictable incomes, will certainly have a harder time meeting the extended sustainability-of-income criteria. Additionally, people who live in high-cost areas may be unable to secure "jumbo" loans (loans above the dollar limits set by FHA and other government programs) or interest-only loans (no initial principal payment) that are popular in these areas.
If the loan terms meet additional requirements, they are considered a Qualified Mortgage under the QM rule, and the lender's protection programs take effect. In general, the QM rule establishes a 3% cap on fees and points (with respect to the mortgage value), but allows a higher threshold for lower loan amounts of less than $100,000. With a few exceptions, QM loans may not be interest-only nor contain negative amortization or balloon payments (exceptions are targeted at rural areas and smaller lenders). The term is also limited to 30 years. Expect tweaks and changes as the rules are established, and when you are ready, verify with your lender what ATR and QM rules apply to your current situation.
According to various estimates, anywhere from 10-20% of current mortgage loans do not meet QM criteria. Realizing that a transition period was necessary, CFPB adjusted the final rule. Until 2021, if a loan can be bought or insured by Fannie Mae, Freddie Mac, FHA, VA or other select government agencies, it's automatically deemed to be qualified even if it doesn't meet the QM criteria.
In short, most people will not be affected by these new mortgage rules, but those who are affected will be hit hard. You should therefore assess your situation honestly — and if you really don't meet the qualifications, increase your saving habits, or buy a smaller house.