As the housing market heats up again following the slowdown of the past few years, many consumers will try to buy a home for the first time or upgrade a home with a mortgage that had previously been underwater. If you fall into either camp, you should know that a new set of rules passed as part of the Dodd-Frank Act - enacted in response to the financial crisis of the late 2000s - will go into effect Jan. 10, 2014. The rules will require lenders of qualified mortgages to conduct more thorough analyses of mortgage applicants' financial information to ensure applicants can afford to repay the loan.
According to the Consumer Financial Protection Bureau, under the Ability-to-Repay rule, the lender generally must consider eight factors. These include your current income or assets, current employment status, credit history, the monthly payment for the mortgage (based on the highest interest rate if it's an adjustable rate mortgage, not an introductory teaser rate) and your monthly debt payments (including the mortgage) compared to your monthly pre-tax income, which is your debt-to-income ratio.
Under the new rules, you'll generally need a debt-to-income ratio of less than 43 percent to obtain a qualified mortgage that's underwritten based on standards considered safe for consumers. Federal rules state that the term of the loan cannot exceed 30 years, and the points and fees paid by the borrower cannot exceed 3 percent of the total loan amount (not including bona fide points or discount points used to pay down the rate of the loan). Under the new rules, qualified mortgages also cannot have risky features such as an interest-only period, when the borrower pays only interest without paying down the principal.
"This sets the bar higher for consumers and changes the game in terms of how people lend and how they qualify that consumer," says Cameron Findlay, chief economist at Discover Home Loans in Irvine, Calif. He estimates that roughly 10 to 15 percent of consumers will not be able to obtain a qualified mortgage and predicts that this will have the largest impact on moderate earners and minorities, especially in higher-cost real estate markets on the coasts. "You'll see some consumers in Midwest regions be in a better position where these rules won't be as impactful" because home prices aren't as expensive, he says. Consumers who do not get a qualified mortgage may pay upward of 100 basis points - 1 percent - on the loan, according to Findlay.
Other mortgage insiders predict a less dramatic impact on prospective homebuyers. "Industrywide, a lot of people [are] freaking out," says Michael Rosenbaum, a mortgage loan originator with First California Mortgage Company. "There's minor shaving of the debt-to-income ratio, but the vast majority of my borrowers are not qualifying at the upper limits. I'm just not finding that everybody wants to push their margins." He says many mortgage originators already look at the same criteria that the new rules require, and there's still some flexibility for underwriting in certain situations. For instance, a self-employed borrower may still be able to qualify with a debt-to-income ratio higher than 43 percent if his or her finances are strong in other areas.
While underwriting standards for conventional loans are tightening up due to new rules, David Reyes, chief investment officer at Reyes Financial Architecture, Inc. in San Diego and a former mortgage banker, says jumbo lenders (those who lend amounts larger than a conventional conforming mortgage) are actually easing up their underwriting requirements in some cases. "The actual jumbo interest rates are almost on par with conforming loans, and you're seeing one-year tax returns with some banks," he says. "Especially the community banks are being more aggressive with income qualifications for self-employed borrowers, which is something you haven't really seen since 2005 or 2006."
Should you hustle to close on a new home in the next month if you think you might not qualify under the new rules? That's not feasible for most people, so Rosenbaum says now might be a good time to instead call a trusted lender and find out where you stand. "People tend to think a lot of things about what their numbers are, but the formula of how we calculate the debt-to-income ratio is complex," he says. "Sometimes people are surprised that they qualify for more than they expected. Or sometimes the answer might be to wait a few more months until you've filed a new tax return if, say, you're self-employed."
Your FICO score is also a big component of the mortgage underwriting process, according to Findlay. The score impacts not only your ability to qualify for a mortgage, but also the interest rate you'll ultimately pay, so you may want to work on boosting your score by making timely payments or correcting any inaccurate information.