On January 10, 2014, one of the biggest changes ever to the mortgage industry will go into effect. A rule created in 2010 in the wake of a housing meltdown will definitely lead to safer mortgages, but could also limit mortgage shoppers’ ability to land an approval.
The Biggest Qualified Mortgage Rule Hurdle
The Qualified Mortgage Rule is part of the regulation mandated by the Dodd-Frank Act of 2010. It states that the borrower must pass an ability-to-repay analysis for their loan to be considered a “Qualified Mortgage,” or “QM” loan. Loans that don’t meet QM standards open up lenders to lawsuits from borrowers and penalties from regulators.
Perhaps the most limiting standard of a QM loan is that the borrower’s debt-to-income ratio (DTI) must be at 43% or below. Up until the rule takes effect, borrowers can be approved at DTIs of up to 50%, and many mortgages fall into this category.
In the past, a high DTI could be overcome by compensating factors. For instance, if someone had a 49% DTI, but $100,000 cash in the bank and a 780 credit score, they would probably be approved.
But the new QM rule may remove the borrower’s ability to overcome high DTI with compensating factors.
A 43% Debt-to-Income Example
The average median household income in the U.S. in 2012 was $51,017 according to the Census Bureau (Statistics from 2012 are the most recent available).
Taking that income, let’s also assume the borrower has a total of $300 per month in payments on auto loans, student loans, and credit cards. Let’s also assume an interest rate at the national average at the time of this writing of 4.29% (4.572% APR). Here’s this borrower’s maximum purchasing power assuming a 20% down loan:
|
Monthly Payment Type |
Monthly Expense |
Percent of Borrower’s Income (Must total 43% or less) |
|
Loans & Credit Cards |
$300 |
7.06% |
|
Property Tax |
$200 |
4.70% |
|
Property Insurance |
$60 |
1.41% |
|
Principal & Interest on Mortgage |
$1267.23 |
29.81% |
|
Total |
$1827.23 |
42.98% |
|
Maximum purchase price for this borrower based on 20% down: $210,000. Average US home price in 2012 according to the US Census: $292,200 |
||
What this tells us is that the average U.S. household income will be even further away from being able to buy the average U.S. home.
QM 43% Rule Alternatives
The Consumer Financial Protection Bureau, or CFPB, is the organization overseeing implementation of the new rules. They have provided a few exceptions to the 43% rule.
FHA Loans
As of yet, the QM 43% rule does not apply to FHA loans. The rule will almost definitely push many home buyers to FHA financing, which is more expensive than other loan types.
VA and USDA Home Loans
Likewise, Veterans Administration loans and United States Department of Agriculture (USDA) Rural Development loans will not be subject QM’s debt-to-income rule. Anyone eligible for these programs – active duty and retired U.S. military Veterans or those looking to buy a home in USDA-eligible areas – should be considering these types of loans first.
Apply for a VA or FHA loan here.
Fannie Mae and Freddie Mac Loans
In addition, the CFPB has made an exception that loans that qualify for purchase by Fannie Mae or Freddie Mac don’t have to adhere to the 43% DTI rule. This is good news, since most loans made today end up with one of these two agencies.
As of the time of this writing, Fannie Mae and Freddie Mac have not limited their DTI to 43. The standard for most of their loans is a 45 DTI. But, it remains to be seen whether they will follow QM’s lead.
Also, it’s a real possibility that individual lenders will impose their own caps to follow QM standards to be additionally protected against lawsuits and regulatory penalties.
Jumbo Loans and other Portfolio Loans
The loans that may be most affected are ones that are not sold to any agency or secondary investor, but are kept on the bank’s books.
Jumbo loans are a good example of portfolio loans. They are good loans, but the loan balance is too big for the loan to be sold to Fannie Mae or Freddie Mac. Jumbo loans are often made to borrowers with large balance sheets, high income, and great credit.
Likewise, lenders make many loans that don’t fit within the Fannie Mae or Freddie Mac parameters. For instance, loans on unique properties, loans to borrowers with high but sporadic income, and construction loans would all fall outside the agencies’ guidelines.
Often lenders choose to make these loans and keep them on their own books, because they are, at the root, good loans. They still can, as long as the debt-to-income ratio is 43% or less. Lenders will most likely end the practice of approving portfolio loans with DTIs higher than 43 after the QM rule is in place.
Interest Only Loans
The new rule will disallow interest only loans, a loan type that requires only the interest due to be paid each month.
Admittedly, many home buyers used this loan to buy more than they could afford in the mid-2000s housing craze. But many savvy homebuyers used the program wisely, and still do. For instance, someone with a commission-only job may want the option to pay less in certain months, and more in others.
Buyers in high-priced areas use this loan feature to buy a home early in their career when their income is expected to rise.
Eliminating the interest-only feature could eliminate options for many first time and repeat home buyers.
Too Little, Too Late?
The new Qualified Mortgage rule is a bit like slamming on the brakes when you’ve already crashed. Lenders and banks these days are very cautious when it comes to lending, and loans originated in the past five years are some of the best in history.
Still, if nothing else, the QM rule will place a permanent chasm between lenders and risky lending, should banks and mortgage companies ever forget the 2000s mortgage debacle.
Only time will tell if the rule will limit home buyers severely. My advice: apply for your loan before January 10, 2014, and avoid the risk altogether.
