January of 2014 saw the Consumer Financial Protection Bureau (CFPB for short) introduce a host new rules and guidelines for real estate mortgages. For the most part, these ‘new’ rules and guidelines have already been around for awhile. The financial industry suffered a crushing blow from the 2008 Financial Crisis and has been extensively regulated every since.
The loose-lending practices that sparked the Great Recession sparked this pithy bit of wisdom from the CFPB director, “common sense turned out not to be so common.” The CFPB was established in 2011 and charged with being the watchdog over a host of financial services – primarily mortgages, credit cards and student loans.
New Mortgage Rules in 2014
In recent actions, the CFPB has introduced and outlined the new “Qualified Mortgage” (QM) and “Ability-to-Repay” (ATR) rules that it is now charged with enforcing. Under these new rules, lenders are required to verify that borrowers can actually afford their mortgages by providing sufficient documentation of specific financial elements such as income, assets, and existing debts. Also, the lenders must verify this documentation using ‘reasonably reliable’ third party records. Recordkeeping is a big part of the official regulation. Working under instruction of the CFPB, HUD has also announced it’s own set of QM rules that apply to FHA Loans, VA Loans and USDA Loans.
What is a Qualified Mortgage?
There are specific limits to which a Qualified Mortgage must adhere. These include limits on the loan features. Mortgages longer than 30 years don’t qualify. Qualified Mortgages also can’t be negative amortization or interest-only and cannot contain a balloon payment with a few exceptions. The points and fees a lender can charge on a QM loan is capped at 3% unless the mortgage is for under $100,000. Some third party charges like appraisals and government program fees are excluded from this limit.
One very specific limit that is significantly tighter than previous guidelines is that the debt-to-income ratio (DTI) not to exceed 43%. Before the Qualified Mortgage rule it was possible to get a conventional loan approval with a debt-to-income as high as 50% and FHA loans were seeing approvals as high as 56% DTI. Dropping these numbers to 43% represents a significant portion of home buyers and refinance candidates. Also, for adjustable rate mortgages the underwriter must use the maximum rate that can be charged in the first five years following the first payment when calculating the payment to figure the dti ratio.
Qualified Mortgage Highlights
- 3% cap on mortgage points and fees unless the mortgage is for under $100,000.
- Borrower debt-to-income ratio capped at 43%.
- Loan term length capped at 30 years.
- Interest-only loans are not allowed.
- Negative amortization loans are not allowed.
- Balloon payment loans are not allowed (with few exceptions).
Temporarily, for about the first four years of QM implementation, if a mortgage is already eligible for purchase or insurance by FHA, VA USDA, Fannie Mae or Freddie Mac, they are considered QM’s. Notably, it is not necessary that they are actually purchased or insured by these agencies, just that they meet the requirements. There are a few QM exceptions for balloon mortgages in certain rural and underserved areas. The CFPB maintains a current list of these areas.
It’s not mandatory for mortgage lenders to offer Qualified Mortgage programs, meaning they still have the capability to offer riskier loan products if the choose. Their non-QM loans won’t have the same legal protection as their QM products against litigation from unhappy borrowers, however.
What is the Ability-to-Repay rule?
Under the ‘Ability to Repay’ rule, creditors generally must consider the following eight factors when determining borrower eligibility:
- Current or reasonably expected income or assets
- Current employment status
- Monthly payment on the covered transaction
- Monthly payment on any simultaneous loan
- Monthly payment for mortgage-related obligations
- Current debt obligations, alimony, and child support
- Monthly debt-to-income ratio or residual income
- Credit history
The ATR rule also states that lenders must use the highest interest rate the lender can charge for the mortgage (known as the fully indexed rate) in calculating the payment. Also lenders must use substantially equal payments amortized over the loan term in their payment calculation, though actual payments can vary. Both of these factors must be used to determine a payment amount that is then used to determine the borrower’s overall debt to income (DTI) ratio.
Notably, nothing in the ‘Ability-to-Repay’ rules creates specific limitations on loan features, points or fees. The rules do not forbid a lender from offering non-typical types of mortgages such as interest only, balloon or negative amortization, and many varieties of products continue to be available on the market. The ‘Ability-to-Repay’ rules only specify the documentation that the lender must obtain and verify, and how the DTI ratio must be calculated.