Right now may be the perfect time to buy a home. But starting on Jan. 10, 2014, the new Ability-to-Repay rule will go into effect, causing lenders to scrutinize mortgage applicant's credit much more closely than in recent years. Though the majority of borrowers will be prepared for the higher hurdles, some will be left in the dust as lenders seek better applicants. If you're preparing to qualify for a new mortgage or refinance your existing one, here are the eight new metrics you should be prepared to review with your lender -- some are old standards in lending, but take note of the new changes.
This hurdle is a given, but since the financial crisis, lenders are taking a much closer look at any applicant's stated income. Be sure to provide your lender with all of the requisite documents to show a trail of your income. And be prepared to explain any income or assets you may have that don't fall into regular categories, such as presents or inheritances.
Much like the income review, lenders want to make sure you have a stable job and that you'll be able to meet your obligations in the years to come. Be sure that you have your employment history, including contacts, ready when you meet with your banker or broker.
3. Credit history
All lenders will pull your credit score and credit reports, but be sure that you've done that before you go. Checking for errors or omissions can save you a lot of time if you're able to correct them before the lender starts their research. Your credit score is vital to the application process as it will impact not only your qualification for a loan, but also the interest rate you will be charged.
4. Monthly payment
This is where the new rules come into play -- more so than the previous points. When lenders look at the affordability of the proposed monthly payments, they will have to calculate what the payments will be at the actual interest rate -- not a teaser rate. During the housing bubble before the financial crisis, applicants were approved based on their initial teaser rate (i.e., 1% for the first year, 7% afterward, etc.). Though borrowers often thought they would be able to refinance before the true rate kicked in, the practice lead to a lot of trouble. Now lenders will be reviewing the applicant's ability to repay at the true interest rate from the get-go.
5. Debt-to-income ratio
By comparing your total debt obligations (including the new mortgage) to your pre-tax income, lenders can determine your ability to repay the loan. In order for a mortgage to be considered safe for consumers under the new rules, an applicant will generally need a debt-to-income ratio less than 43%. Though there are some instances where this rule can be flexible, such as for self-employed persons, lenders generally don't want to see a large percentage of your income dedicated to debt obligations.
6. Mortgage term
Under the new rules, a qualifying loan cannot have a term exceeding 30 years. In the past few years, lenders have been offering 35-, 40-, and 50-year terms in order to attract borrowers. The longer-term loans were often easier to qualify for and featured much lower monthly payments due to the extended term. Though there is some initial appeal to the longer term, there's little use of these types of terms if you're looking to save money in the long run.
7. Points and fees
If you are paying a large amount of fees or points, your mortgage may not qualify. Excluding bona fide points, or discount points you pay to reduce your interest rate, new qualifying loans cannot include fees or points that exceed 3% of the total loan amount.
8. Risky features
The last barrier for an applicant to cross is loan-centric. If you're interested in a new mortgage that features a period of interest-only payments, don't expect to get qualified. These types of risky features were all the rage during the housing bubble, and a key area that regulators want to discourage.
Most of the sneaky loan features have been ousted from the market following the financial crisis. But regulators want to make sure the right buyers are being approved for qualifying mortgages, leaving some out of the race for the warming housing market. Though the new rules could effect up to 10-15% of those applying for a mortgage, the majority of borrowers will not have too much trouble. Most lenders had already tightened their standards following the recession, so buyers may be used to the new hurdles. Either way, being prepared for the tightened regulations and scrutiny will only make it easier during the approval process.
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