By Laura Ferraro, Senior Vice President
On January 10, 2014 the Ability To Repay and Qualified Mortgage Provisions of the Dodd-Frank Act
, went into effect to create a balance between credit availability and proper consumer protection. The new rules were implemented to combat any lingering abusive industry lending practices that were not already tightened after the financial crisis. We applaud this, of course, as the rules help ensure that all consumers get a mortgage they can afford to repay throughout the term of the loan. Additionally, the ruling helps lenders reduce their risk of receiving a lawsuit from borrowers by ensuring issuance of "safe" qualified mortgages.
These new rules, written by the Consumer Financial Protection Bureau (CFPB), will also prevent any mortgage loan originators who were inclined to steer consumers into agreeing to a loan with higher rates or unfavorable terms for higher compensation from doing so. We are happy to say these types of practices are now banned.
In 2012, real estate data provider CoreLogic reported only 12.8 percent of new mortgages didn't meet the new qualified mortgage standard.1
It is expected that many borrowers will not be affected by the new rules; however some, for example the self-employed, may have to provide significantly more documentation to prove their ability to repay the loan.
So what are the rules and how do they protect consumers?
Lenders Must Determine Ability to Repay
The "Ability to Repay" rule states that before you get a mortgage loan, lenders are required to document and verify a borrower's ability to repay. This may amount to increased paperwork and processing time, so plan accordingly.
To determine whether the borrower can pay back the loan, a lender will look at income, assets, credit history, and a 43 percent debt-to-income ratio or better, plus other financial indicators. A lender cannot determine your ability to repay using low introductory "teaser" rates, and must consider the highest interest rate that you may have to pay over the term of the loan.
When qualifying a borrower for a mortgage, lenders will review the borrower's financial information, including:
What Is A Qualified Mortgage?
- Your current employment status
- Your current income & assets
- Your credit history
- The monthly payment for the mortgage loan
- Monthly payments on other mortgage related expenses; i.e. property taxes
- Any other simultaneous loans for the property; i.e. a home equity loan
- Monthly obligations and debts including homeowner's insurance, HOA dues, utilities, etc.
- Your debt-to-income ratio
A "Qualified Mortgage" is the name the CFPB gave to "safe" mortgages. It imposes strict lending standards that include many of the best practice standards already in place. Qualified Mortgages cannot have the following so-called risky loan features:
- An "interest only" period, when only interest is paid without paying down the principal.
- "Negative amortization," when the loan principle increases over time, even though payments are made.
- Balloon payments which are larger-than-usual payments at the end of the loan term, except in some limited circumstances.
- Loan terms longer than 30 years.
- Upfront fees and charges that exceed a pre-determined threshold. These include things like title insurance, origination fees, and points paid to lower interest rates.
A "Qualified Mortgage" generally requires a borrower's total monthly debt - including the housing payment - doesn't exceed 43 percent of the borrower's monthly pre-tax income. In some limited circumstances, lenders may decide that a debt-to-income ratio of more than 43 percent is appropriate.
In certain circumstances, even if a loan is not a qualified mortgage, the loan may be made as long as a reasonable, good-faith determination has been made that the consumer can repay the loan based on common underwriting factors.
Have a question on the new mortgage rules? Give us a call at 866-224-1379.