I’ve been asked to comment on what a qualified mortgage is and what it means. I’ll skip the history lesson, but starting January 1, 2014 there will be a new category of loan called a qualified mortgage. This discussion is just meant to hit the highlights. More in-depth coverage is cited at the end of this article.
Where did the Qualified Mortgage Rule Come from?
The CFPB (Consumer Financial Protection Bureau) was put in place to prevent abusive lending practices that were rampant in the bad old days. They have decided that there are probably parameters that they can apply to every loan which, used as hard-set rules of underwriting and documentation, would prevent lenders from making loans that borrowers cannot afford to pay back. This is known in the CFPB world as the ability to repay rule.
What is a Qualified Mortgage?
Starting January 1, a mortgage will either be qualified or non-qualified, depending on whether or not it meets the following criterion:
- Your total debts cannot exceed 43% of your gross income. So, if you add up principal, interest, taxes, insurance and all other debts, your monthly obligations cannot be more than 43% of your income. If your gross income is, say, $8,000 per month, your total monthly obligations cannot exceed $3,440.
- The “qualifying interest rate” used to determine the payment for qualifying purposes must be the highest rate possible under the terms of the contract in the first five years. This will pretty much make adjustable rate mortgages with initial fixed terms of less than five years difficult to do.
- The total fees charged by the lender cannot exceed 3% of the loan amount. This one is controversial; I’ll discuss why below.
- Certain high-risk features will not be allowed. For instance, interest-only, negative amortization, loans amortizing for periods longer than 30 years and loans with balloon payments will not be considered qualified mortgages.
So can lenders only make loans that fit within these guidelines?
Actually, no. Lenders can still choose to make non-QM loans. However, there is an incentive to make loans that do fit within the guidelines. The greatest risk to lenders over the last five or six years has been lawsuits. Borrowers have been suing them for making loans that the borrower cold not repay.
Lenders can protect themselves by making only good loans, but no system is perfect, things happen even to good borrowers that prevent them from being
able to make payments, and once attorneys find a nice little wellspring of money they tend to be hard to stop. Regardless of whether a lender made a good-faith effort to make a good loan, they can still be sued and be forced to defend their actions.
Starting January 1, if a lender makes a qualified mortgage (and can document that it meets all the criterion of the QM rule) if they are sued by a borrower for making a loan that the borrower cannot repay, the case is dismissed. Period. This is known as a “Safe Harbor” provision.
There will be demand for loans that don’t fit into the QM box, of course. I believe some (not all) lenders will step up and make these loans. But greater risk (no safe harbor protection) would have to mean higher pricing. In other words, if you don’t fit neatly into the box you will probably still be able to get a loan, but you’ll have to pay more. Interest rates could be higher, points and fees could be higher, and the use of mortgage insurance could expand.
So what are the implications?
The greatest concern is that even with today’s tight underwriting guidelines, it is estimated that 20% (give or take) of the loans being written today would not qualify under the CFPB guidelines. We have to ask what would happen to those borrowers, and what impact it could have on the real estate market.
In high-cost areas like the Bay Area this could seriously hamper home sales. Even highly qualified buyers tend to have pretty high debt ratios because of the high loans amounts and high real estate taxes. With rising interest rates, the possibility that the high-balance conforming loan amount may be eliminated*, and expanded requirement of mortgage insurance, there are some folks that are just going to be squeezed out of the market. How many isn’t clear, but some for sure.
How does this impact me personally?
If you are looking to refinance or purchase a home and fit within the guidelines, you have nothing to worry about. If you don’t fit, then getting a loan after January 1 will almost certainly be more expensive than it would be today.
If you are thinking of selling your home, after January 1 there will be fewer buyers who qualify to purchase your home. Right now in our area it’s a seller’s market, and buyers have to compete and bid for your home. Come January that might not be the case.
Wait – what about the 3% cap on fees?
I’m glad you asked – I nearly forgot. If the rule says that you cannot pay more than 3% of the loan amount in fees, you would expect this to mean that all the fees you pay for the loan have to be equal to or less than 3% of the loan amount, right? In other words, if it’s a charge in escrow that you pay either in cash or by accepting a higher interest rate in exchange for the lender financing the fees, we would count it. You would be wrong.
In a bewildering display of logic, the CFPB decided that fees that you do pay such as title, escrow, appraisal and recording fees would be exempt from being included in the 3% cap. However, fees that you don’t pay, such as the compensation the lender pays to independent brokers, will be counted. OK, maybe that makes sense. Except that the compensation that they pay to their own staff for the same services is not counted.
This little arcane rule is under reconsideration, as the CFPB has finally realized that it would put brokers at a severe disadvantage and limit consumer choice in terms of where to get their loan. Most of the brokers I know are considering moving to a mortgage banker, where they would have significantly fewer options for shopping your loan, but would be making qualified mortgages by definition. For the sake of you, the consumer, let’s hope they change this rule. We can compete just fine, thank you, if we all play by the same rules.
For a little more depth on the Qualified Mortgage Rule, see:
My name is Casey Fleming. I originate mortgage loans in California and am based in Silicon Valley.
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