Starting in a few weeks, the face of the mortgage market is expected to change – some say, radically.
That’s because starting January 10th, 2014, the Consumer Financial Protection Bureau (CFPB)’s new mortgages regulations are due to set in. In case you haven’t heard of it, the CFPB is a new regulatory body established through the landmark financial regulatory overhaul, Dodd-Frank. It’s goal: “to make markets for consumer financial products and services work for Americans.” (Sidenote: we think that’s a great goal).
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Under the new mortgage regulations, it is estimated that somewhere between 20% and 50% of mortgages originated today would fail to qualify as a safe loan, according to recent studies by mortgage compliance and research firms.
But what does this actually mean for current or aspiring homeowners? What do you need to know about these rules? And how might your decision-making change?
Rules Enhance Burden on Mortgage Originators to Protect Consumers
First, a quick review of the rules.
Among the new suite of mortgage rules that the CFPB finalized in January 2013, the first rule to pay attention to is called “Ability-to-Pay.” To be a “Qualified Mortgage” (“QM”) – the second rule to pay attention to – the mortgage underwriter must use third-party records to verify the following:
- Current or reasonably expected income or assets
- Current employment status
- Monthly payment on the loan
- Monthly payment on any other simultaneous loans
- Monthly payment for mortgage-related obligations
- Current debt obligations, alimony and child support
- The monthly debt to income ratio
- Credit history
The second rule, the QM standard, outlines the criteria a loan must meet in order to be considered for purchase by Fannie Mae and Freddie Mac. The following list summarizes the requirements:
- No excessive fees (over 3% of the value of the mortgage)
- No “risky” features, such as interest-only, negative-amortization, 30-year terms or balloon loans
- No more than 43% of a borrower’s monthly income can go towards housing-related expenses
- If the lender fails to do this, and the borrower is unable to pay the mortgage, the borrower may be able to sue the lender
So Are Radical Changes Ahead?
After reading headlines about the dramatic impact, we decided to sort through to see what changes really mean and can track the following three impacts:
1. More Documentation. The simple days of filling out a loan application and attaching a credit report to get approved for a mortgage are history for most of us. Your W-2, bank account statements, investment account statements and tax returns are all fair game to be added to the list. But keep in mind: while new rules mean more work for lenders, the intention is that for you, this paperwork is more straightforward and easy to read. We’re inclined to think that’s a net positive.
2. Stricter Access to Credit, or Harder to be Predatory? The answer to this question is both. It may be that the 43% income requirement makes it harder for certain groups – first-time homebuyers, the self-employed with variable incomes, and retirees with assets but no income – to get credit. But on the other hand, the QM criteria (which, notably, are generally recognized as the line between prime and subprime) in practice are actually making it harder for lenders to get away with loan features that disadvantage borrowers. A closer look at the numbers of the study with the disquieting headline that “20% of mortgages originated today would not qualify,” shows that reason the majority of those loans fail the fee test (fees are more than 3%).
3. Rates May Change – but Not Likely Due to Legislation. Some say that higher administrative burdens might force banks to charge higher interest rates and may even put small lenders out of business. While this is theoretically true, it is balanced by the fact that Fannie and Freddie will buy mortgages that meet the QM standard – which puts downward pressure on rates. While it’s true that rates may go up, it’s likely to be due to other economic factors.
What This Means for You: Stay the Course.
With headlines about the dramatic shift in mortgage lending, it might be easy to think that the market for mortgages will disappear.
But after our review of the CFPB’s new mortgage rules, it seems like they should not dramatically shift your home-buying decision. A good rule of thumb is to buy a home if you’re going to live there for 6+ years and you would rather live in the place that you’d buy than the one you’d rent. And when you’re deciding on your mortgage, think about it in the context of your entire wealth picture. (For tips on how to do so, see our article on how your mortgage impacts your investment strategy.)
Some final tips: if you’re considering a new or first-time mortgage, check your credit report. Correct any errors and clean up any problems. If you’re on the border of the Ability-to-Repay and you’ve got any current debt that you might pay down, it might be time to do so. The best credit gets the best rates and terms.