New mortgage rules are on tap. Starting January 10th a slew of new mortgage requirements came into play, but fear not, despite Internet rumors to the contrary, loans will be widely available. You won't need 20 percent down, and no blood tests or hair samples will be required.
The new guidelines are a by-product of Wall Street Reform and the Dodd-Frank legislation passed in 2010. The core idea is to reduce mortgage lending risk because less risk means lower mortgages rates and fewer foreclosures. These are qualities which not only benefit borrowers but also lenders, because fewer foreclosures mean reduced losses and higher profits.
So what are the new rules?
There are thousands of pages of guidelines, but in basic terms the new rules look like this:
First, the world of residential real estate lending is divided into "qualified mortgages" and mortgages which do not meet the QM definition. Lenders are entirely free to make both qualified loans and mortgages which are not qualified. However, by making qualified mortgages, lenders can avoid tons of liability, an important matter given that lenders have shelled out more than $100 billion in settlement money since the foreclosure meltdown began, a tab which is certain to rise.
Second, to create a qualified loan, the lender must assemble a fully-documented application package that includes verification of the borrower's ability to repay the loan. No-doc and low-doc loan applications are not allowed in the qualified mortgage category -- but lenders are entirely free to make such loans if they want. As the Consumer Financial Protection Bureau explains, if lenders choose not the follow the qualified mortgage guidelines, "they can still make a loan based on their reasonable, good-faith determination that the borrower has the ability to repay it."
Third, qualified mortgages are plain and dull, they contain no "gotcha" clauses and no surprises. Basically, QM financing includes loans with terms that don't exceed 30 years, with up-front points and fees limited to three percent of the loan amount in most cases. Interest-only loans and negative amortization financing -- such as option ARMs -- cannot be qualified mortgages. Balloon notes are also excluded from the QM definition.
Fourth, not only are points and fees limited, qualified mortgages also hold down interest rates. Mortgage interest for QMs is limited to not more than the Average Prime Offer Rate or APOR plus three percent. In practice, many loans will be priced at the APOR plus not more than 1.5 percent to meet certain legal standards. In effect, most borrowers approved for mortgage credit will find financing within a small pricing band.
Fifth, rumors that borrowers will now need 20 percent down payments to buy real estate are nonsense. As the CFPB explains, the new rules "do not establish a minimum down payment." VA loans and FHA mortgages are automatically considered qualified mortgages, as are loans which meet Fannie Mae and Freddie Mac standards. In other words, financing with 3.5 percent down, five percent down and even zero percent down will remain available to qualified borrowers.
Sixth, the lending system will not slow down because lenders had insufficient time to prepare for the new rules. Most lenders are already in compliance -- 92 percent were making compliant mortgages before the new rules went into effect, according to the CFPB. In the wake of the foreclosure crisis, lenders were so concerned about being forced to buy back bad loans that they toughened up guidelines voluntarily -- tightening up their underwriting by applying overlays -- guidelines tougher than government-required limitations.
New Mortgage World
What will be the real effect of the new rules on lenders and borrowers?
We know that existing home sales are up and new home construction has risen, trends which would not be possible without the widespread availability of mortgage credit. Foreclosures are down, the by-product of less risk. Lender profits are up, and today nobody believes the financial system needs to be bailed out again. Even the Federal Reserve has begun to reduce its purchases of mortgage-backed securities.
But what about those vague worries that real estate lending is somehow "too tight?" It's clear that mortgage applications are flying through the system. Millions of borrowers have financed and refinanced during the past year or two, and if they can do it, so can you.