If you're in the market for a mortgage, then a new set of rules that took effect on Friday should be high on your radar.
In an effort to stamp out the riskiest types of mortgages that fueled the housing bubble and subsequent crisis, the Consumer Financial Protection Bureau implemented two fundamental changes to how lenders make home loans, known as the ability-to-repay and the qualified-mortgage rules.
With this in mind, I asked mortgage professional James Adair with the Aspire Mortgage Group in Portland, Ore., to tease out how these new standards are likely to impact prospective borrowers.
Q: Can you explain what a qualified mortgage is and why homebuyers should care about it?
A: This is the new verbiage invented by the federal government that encompasses a variety of rules mortgage lenders must adhere to. On paper, the qualified mortgage rules only marginally appear to cramp a borrower's ability to get a mortgage. For instance, according to USA TODAY, the CFPB estimates that 92% of mortgages in the current marketplace already meet the new requirements.
Borrowers should care because, in simple terms, the mortgage process automatically became more conservative on January 10th. Not dramatically so, but more conservative nonetheless.
Q: How are the requirements under the new qualified mortgage standard different from before?
A: Here's one way to think about it: The new rules are designed to reduce the risky type of lending that fueled the housing crisis.
Under the ability-to-repay rule, which accompanies the new qualified mortgage standards, lenders must make a bona fide effort to determine whether or not a borrower can actually afford his mortgage payments. As such, lenders are now obligated to document and verify an applicant's income, assets, credit history, and current debt load. Gone are the days of no- and low-documentation loans.
Lenders are also now prohibited from lacing mortgages with the risky features that prevailed before the crisis. Low "teaser" rates are out, as are negative amortization loans, where a borrower's monthly payments are less than interest accrued. There is also a new upper limit to a borrower's monthly debt-to-income ratio. It's now 43%, whereas it was 45% previously.
One of the biggest changes concerns fees. To be considered a qualified mortgage, a loan can no longer have fees that exceed 3% of the loan amount. While it's rare that a conforming or FHA/VA loan would have fees that exceed that threshold, the one area that could be affected is private-label mortgage insurance, which oftentimes call for upfront payments at close. For instance, a PMI policy might cost 1.37% of the loan amount, limiting any remaining fees to 1.63% of the mortgage.
Q: Is this a dramatic shift in the mortgage market, or rather a small adjustment?
A: In a way, it's both. The biggest change is that we now have tangible federal rules provided by the government combined with a new enforcement agency, the Consumer Financial Protection Bureau. It's the mere existence of the CFPB more than anything else that marks the new regulatory dynamic -- which, it turns out, is a pretty big deal.
Underwriters and lenders are now going to be on their best behavior, and "jump-ball" type decisions that an aggressive underwriter might have allowed to get approved in the past are going to be looked at much more conservatively. No lender in America wants to be the first to challenge the rules or push the envelope. The penalties are very stiff; stiff enough, in fact, to potentially put a small mortgage company out of business.
Thankfully, the new rules appear to be largely on par with how things had been going in the last 18 months anyway. So fundamentally, things aren't that different, and particularly for borrowers. But I can tell you that being a mortgage professional feels a bit different, and I can only imagine what it must feel like to own or manage a mortgage company in this environment. Probably not awesome.
Q: Are banks likely to write mortgages that don't meet the new standard? And, if so, under what circumstances would they be willing to do so?
A: This is the most interesting thing to pay attention to. Just recently, for example, The Wall Street Journal had an article about how Wells Fargo (NYSE:WFC), Bank of America (NYSE:BAC), and JPMorgan Chase (NYSE:JPM) are all preparing to make mortgages that fall outside the new standard. These are likely to be loans to high net worth individuals that the banks will keep on their balance sheets to appease existing customers.
Beyond this, I think it's very likely that we'll see new outlets for loans pop up in the next 12-24 months. It could be the dawn of a new mortgage marketplace similar to what we used to call "sub-prime."
Certainly there will be, and always have been, high-quality loans that the current mortgage industry can't or won't make, and the qualified mortgage standard will increase this population. To the extent that there will be a new type of mortgage lender that doesn't sell into the current Fannie/Freddie system, they will probably allow for some expanded kind of income documentation. To me, that seems to be the most obvious place where the good borrowers are getting shut out right now.
Q: How is the new qualified mortgage standard likely to impact the housing market, and why?
A: The easy answer here is that it will be a drag on the housing market in the short term. To what extent, I can't say exactly; it may not even be noticeable. But long term, if we get private capital to flow back into this space for borrowers who don't meet the qualified mortgage requirements, it could end up being a boon to the housing market!