by Kimberly Rotter | Jan. 22, 2021
Think your debt means you can't qualify for a mortgage? This change might make the difference.
To promote access to responsible, affordable mortgages, the Consumer Financial Protection Bureau (CFPB) issued two changes to mortgage standards in late 2020. The new mortgage rules will help more borrowers get home loans.
We spoke with Melissa Stegman, senior policy counsel for the Center for Responsible Lending, to find out whether the new mortgage rules are good for consumers, lenders, or both.
To understand the impact of the recent mortgage rule changes, it's important to understand what the status quo was for mortgages prior to 2021.
After the housing market crash and Great Recession, the federal government created a class of mortgage with borrower protections built in. This type of home loan is called the qualified mortgage.
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A qualified mortgage has certain stable features that are designed to make the loan less risky. This helps borrowers avoid unaffordable home loans.
A qualified mortgage generally can't contain these features:
Furthermore, the lender must make an effort to determine that the borrower has the ability to repay the loan (called the ATR rule).
Mortgage lenders limit the applicant's debt-to-income ratio (DTI) for most mortgages. Under old qualified mortgage rules, the borrower's DTI -- their total required debt payments plus the proposed housing payment -- could not exceed 43% of their income.
The Center for Responsible Lending says that the DTI limit unfairly excluded certain creditworthy borrowers -- and especially consumers of color.
The first change was an update to qualified mortgage standards.
Because many lenders only make qualified mortgages, if a borrower had a DTI above 43%, the application was denied. At the same time, an exemption allowed many loans to retroactively be considered qualified mortgages even when the borrower did have a DTI over 43%.
Mortgage analysts looked back at loan performance data since the Great Recession and found that DTI is not a strong predictor of default. In fact, there is a stronger correlation between the loan's price and its performance.
Stegman explains that DTI needs to be part of holistic underwriting, but not with a strict cutoff. "Too many people were excluded" from home loans, she says. "Data shows that DTI is a limited predictor of mortgage risk. There was too much hyper-focus on this one element [of a mortgage application]."
The Center for Responsible Lending submitted a letter to the CFPB in support of the removal of the DTI limit. Several national organizations that advocate for the rights of minority and underserved borrowers also signed the letter.
The CFPB agreed with the Center for Responsible Lending and other consumer advocates. Since a loan's price is more closely correlated with the likelihood of default, the DTI limit was eliminated. The Center for Responsible Lending applauded the change.
Lenders are no longer restrained by a 43% DTI to make a qualified mortgage. Instead, a home loan is considered a qualified mortgage if it meets other qualified mortgage requirements, including price limits.
The pricing rule says that the loan's annual percentage rate (APR) must not exceed the average prime offer rate for a comparable transaction by 1.5 percentage points. Lender fees are also limited. For loans over $111,260, upfront points and fees cannot exceed 3% of the loan amount.
It may seem odd to say that a loan's price tag can tell us how likely it is that the borrower will repay the loan. In fact, pricing is not the only factor at play. The lender must also confirm the applicant's income and assets, verify the ability to repay, and otherwise qualify the applicant.
After the new mortgage rules took effect, many lenders raised their DTI limit to 50% or more.
The second new mortgage rule creates a new class of mortgage called seasoned QMs (qualified mortgages). This rule applies to non-qualified mortgages that a lender has kept in its portfolio for at least 36 months. Even if the loan didn't originally meet the requirements for qualified mortgage status, it can become a qualified mortgage after three years. To be eligible, the loan must meet QM standards and performance standards. For example, the loan may not have any 60-day delinquencies during the seasoning period.
"Most loans are in the QM space because it's safer for the lender," says Stegman. In exchange for meeting qualified mortgage standards, the lender is protected from legal challenges later on. For example, if you default on your mortgage and the lender forecloses, you might not be able to successfully claim in court that the lender was irresponsible and issued you a loan that you couldn't afford to repay.
"QM standards benefit both the borrower and the lender," adds Stegman. Without them, loan prices would be higher, and some loans would not be made at all.
"QM standards also ensure that the borrower won't be in a loan full of red flags like payment shock or excessive fees," says Stegman. "We encourage lenders to provide the safest loans to borrowers. We want people to have access to responsible, sustainable homeownership."
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