As we roll into 2014, some of the loose lending problems of the last decade still raise their heads. I say that because of a situation with some clients, I met with this weekend. They refinanced in 2005 into what they thought was a fixed loan, but come to find out it was an adjustable rate. Fortunately, rates are still low so these borrowers did not see a big adjustment to their payment. If rates were high, they would have seen an upward adjustment to their rate every 6 months.

What is the 2014 Qualified Mortgage Rule?

Problems such as these led to the passing of the Dodd-Frank Wall Street Reform and Consumer Protection Act and the creation of the Consumer Financial Protection Bureau (CFPB). And with the creation of the CFPB, we now have a law that requires mortgage lenders to consider the consumer’s ability to repay a mortgage loan. Effective January 10, 2014, some mortgage rules changed and could influence the qualification of mortgages and the types of mortgages consumers can get.

Bottom line, lenders will be required to ensure that the borrowers have the ability to repay their mortgages. In return for making sure you can repay your loans, the lenders will be protected from borrower lawsuits so long as they issue “safe” mortgages that follow guidelines. Thus, the creation of the “Qualified Mortgage” by the CFPB.

In 2012, only 12.8 percent of all new mortgages did not meet the new requirements. And most borrowers will not have a problem buying a home or refinancing as a lot of the lenders have already tightened their lending standards.

So what does the new Qualified Mortgage mean? It means we now have to look at certain requirements to determine whether borrowers have the ability to repay their loan. These are (1) current or reasonably expected income or assets; (2) current employment status; (3) the monthly payment of the covered transaction; (4) the monthly payment on any simultaneous loan; (5) the monthly payment for mortgage-related obligations; (6) current debt obligations, alimony, and child support; (7) the monthly debt-to-income or residual income; and (8) credit history.

We normally calculate the debt-to-income on an adjustable-rate mortgage at the initial lower rate which will help you to qualify for more home.  With the new qualified mortgage, you will have to qualify at what we call the “fully indexed” rate, or what the rate would be adding the margin and the index together or the introductory rate, whichever is higher.

For instance, let’s say you are applying for an ARM loan with an initial rate that’s fixed at 3.5% for five years, then start adjusting. During the adjustable period, the rate is based on the index and the margin. If the index were currently at 3% and the margin were at 2.5%, the loan would have to be approved at 5.5%.

Another big factor to the Qualified Mortgage rule is that lenders need to look closely at your total debt-to-income ratio. In the past, we were able to get loans closed with ratios as high as 49%. In other words, a borrower could have credit card payments, auto loans, and other monthly debt payments, plus a mortgage payment equal to 49% of their gross income.

What does that mean for your mortgage application?

No longer will we see these ratios. Most lenders will only allow a total debt ratio of 43% to qualify for a “QM” loan. This will make it easier for clients to still pay other obligations they may have.  While there are some borrowers that can qualify at a higher ratio, they will be considered on a case-by-case basis.

There are some loans that will no longer be considered for approval under the qualified mortgage.  Loans with negative amortization, interest-only payments, balloon payments, and terms exceeding 30 years, and “no-doc” loans where the creditor does not verify income or assets do not qualify as a Qualified Mortgage.

One of the other concerns that came out of 2007 & 2008 was the amount of points and fees that were paid by the borrowers. In some cases, this made loans a lot more expensive. Under the new rules, a loan cannot be a qualified mortgage if the points and fees paid by the borrower exceed three percent of the total loan amount, although certain “bona fide discount points” are excluded for prime loans. Discount points refer to fees borrowers pay that directly lower their interest rate.

Here at Absolute Mortgage, we will adhere to the new rules of Ability to Repay/Qualified Mortgage rules. And this should make it easier to make sure that our clients can live in their homes and not get into the financial problems of the past.