It just got harder to get a mortgage, but that’s not necessarily a bad thing.
Today, new rules from the Consumer Financial Protection Bureau (CFPB) went into effect requiring lenders to make a “good-faith, reasonable effort” to ensure that borrowers are able to repay their loans.
During the subprime mortgage crisis, many consumers were allowed to take on debt that they had no way of repaying. At the height of the mania, in mid-2007, such bad loans made up 14 percent of all mortgages.
The new rules, part of the Dodd-Frank regulations, are meant to prevent such a crisis again by disqualifying risky borrowers and equally risky mortgage products from entering the market. The good news is that the market has largely already shifted toward tighter standards, so the latest regulations shouldn’t cause a huge shock.
“Over the last couple of years, lending underwriting standards have been tight in the way of verifying income, assets and requiring a down payment and providing multiple documentation streams, and not allowing you all kinds of budget-stretching flexibilities,” says Keith Gumbinger, vice president at HSH, a mortgage information website.
This isn’t to say there will be no effect. Greg McBride, senior financial analyst at Bankrate.com, says, “It will certainly prevent the last bubble from happening again, but it’s also going to mean that first-time homebuyers will have a harder time qualifying or will qualify for a lot less.”
Here’s our cheat sheet on the new rules, which apply to new mortgages applied for on or after January 10 – and how they could affect you.
1. Ability-to-Repay Rule. The CFPB will now require lenders to verify your income, assets, debts, credit history — and will be prohibited from qualifying you based on “teaser” interest rates that you would not be able to pay once the introductory period is over.
2. A New Category: Qualified Mortgages. The CFPB is defining a new class of mortgages called a qualified mortgage (QM), which is a loan that a borrower should be able to repay, protecting the lenders from legal liabilities. For instance, a QM term cannot be more than 30 years, and it can’t have risky features such as interest-only payments that could later go up, or negative amortization, in which unpaid portions of the interest are added to the principal. A qualified mortgage also limits the amount lenders can charge in points and fees, and requires borrowers to have a total monthly debt-income ratio of 43 percent or less.
Some lenders will still offer non-QM products, but since those loans don’t offer the same legal protections to lenders, they’ll be more expensive for borrowers.
3. Protections against ‘Steering.’ Anyone being paid to help you find a loan (such as a mortgage broker) can’t be paid more to steer you to a higher-cost mortgage, nor can he charge both a lender and borrower for the same loan.
4. Protections from Servicing Abuses: Mortgage statements must now tell borrowers how much is owed, how much is applied to principal, interest, escrow, how previous payments were applied, and more.
What the Changes Really Mean
The new rules will still affect the market, Gumbinger of HSH says: “Any time there’s a rule change, it adds some cost to the origination of a mortgage, so there’s likely to be some increase in fees. Ultimately costs will rise to borrowers — but not by much.”
Any increase in fees, of course, comes on top of rising interest rates and increasing home prices, both of which are making homes less affordable for the typical borrower than they’ve been in years. Today’s 30-year, fixed-rate mortgages are running about 4.6 percent, and they’re expected to pass the 5-percent threshold by the end of this year, according to the Mortgage Bankers Association. That may not seem like a huge jump, but every extra point on a mortgage decreases buying power by about 10 percent.
Beyond affordability, the change likely to have the biggest impact on homebuyers is the 43 percent monthly debt-to-income (DTI) ratio requirement for qualified mortgages. “Most people have proof of income, pay stubs, and tax returns, but that 43 percent debt-to-income ratio could trip up some people,” says McBride. “Small business owners that have had a couple of down years – their income will be depressed during that time, and they’ll have a hard time qualifying.” Those who get paid seasonally, earn big annual bonuses, or the self-employed may also find it more challenging to meet this standard, says Gumbinger.
Middle-income Americans who already have car and students loans may find themselves bumping up against the ratio as well. Homebuyers typically aim to keep their total housing costs — mortgage, escrow, homeowners’ dues or assessments – under 30 percent. If they manage to do that, then their remaining installment debt can’t exceed 13 percent of their monthly income. “For anyone with a car loan, that just sinks it right there,” McBride says. “It doesn’t leave a lot of wiggle room for somebody who has existing installment debt such as a car loan or student loans.”
Still, for most borrowers, the new rules won’t mean huge changes. “Expect a little bit of confusion in the beginning of the year,” says Gumbinger. “Some lenders are well-prepared for the change, and others are cramming in at the last minute. There are a lot of moving parts to this. Some systems have to be put in place, and it’s likely to slow down the process somewhat.”
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