A federal government agency has issued new rules for home mortgages that will rewrite the way that banks decide who gets a home loan.
The rules are designed to prevent a replay of the housing crisis that resulted from a flood of easy-money loans a few years ago. However, the new rules could have the effect of tightening the availability of mortgages, at a time when banks are already being extremely strict about granting loans.
Under current law, if a homeowner defaults on a mortgage, the homeowner can potentially sue the lender for issuing a loan that the homeowner couldn’t reasonably be expected to pay off.
The way the new rules work is that they give banks and other lenders a “safe harbor” – that is, they say that if a bank issues a loan that meets certain criteria (called a “qualified” mortgage), then it can’t be sued if the borrower defaults.
This will create an enormous incentive for banks to issue only mortgages that are “qualified.” While it’s possible that some lenders will continue to issue other types of mortgages, this will be the exception rather than the rule, because lenders will be facing potential legal liability if they do so.
The new rules will take effect next January.
If you’re a borrower, this means that you’ll have a much easier time getting a loan if you first make sure that you qualify for a “qualified” mortgage.
The most basic new rule is that a mortgage is “qualified” only if the borrower’s total debt payments – including not just the mortgage, but also car loans, educational loans, etc. – are no more than 43% of the person’s pre-tax income.
In addition, lenders are required to carefully scrutinize borrowers’ employment status, income, and credit history to verify that they will be likely to be able to repay the loan.
To put that in perspective, of all the mortgage loans that were issued in the U.S. in 2011, only about three-quarters would have been “qualified” under these rules.
However, because today’s real estate market is still in recovery mode, the Consumer Financial Protection Bureau – the agency that issued the rules – provided a temporary alternative.
That is, even if a borrower doesn’t qualify under the 43% test, the borrower might still qualify if he or she would pass an automated mortgage-granting test used by Fannie Mae, Freddie Mac, or the Federal Housing Administration. It appears that most of the mortgages issued in 2011 that didn’t pass the 43% test (but by no means all of them) would still have qualified under one of the automated tests.
This alternative won’t be around for long; it lasts only until the government’s conservatorship of Fannie and Freddie ends, or in seven years, whichever comes first.
Also, the alternative test can’t be used for a so-called “jumbo” mortgage. These are mortgages that are larger than the government’s loan ceilings, which are $417,000 in most of the country (but can be as high as $729,750 in certain high-cost markets).
Here are some other important provisions of the new rules:
- There’s no minimum down payment for borrowers, as long as they meet one of the two tests, and no minimum credit score. (Many people were afraid that the rules would require a high down payment to qualify.)
- In deciding whether a borrower meets the 43% test, a bank can’t offer a low “teaser” rate or introductory adjustable rate and qualify the borrower on that basis. Instead, the borrower must meet the 43% test based on the highest rate that will apply during the first five years of the loan. For this reason, it’s expected that adjustable-rate mortgages will become more uncommon, and banks will focus much more heavily on traditional 30-year fixed-rate loans.
- Certain types of loans, such as those that allow interest-only payments and those in which the principal can increase over time, cannot be “qualified” regardless of whether the borrower meets the 43% test. These loans have largely disappeared anyway, but the new rules will probably make sure they never come back.
- Loan-origination fees will be capped at 3% of the loan amount, although there may be some exceptions for loans under $100,000.
- Lenders will get additional protection from liability if the loan has a prime mortgage rate, or one within 1.5% of the national average.