Reform Comes Up Short in One Area
However, one of the great curiosities of the new regulations is that they continue to allow mortgage lending for borrowers with large monthly debts.
“The general rule,” says the Consumer Financial Protection Bureau, “requires that monthly payments be calculated based on the highest payment that will apply in the first five years of the loan and that the consumer have a total (or ‘back-end’) debt-to-income ratio that is less than or equal to 43 percent.”
Under this final rule, a borrower can have housing debts for mortgage principal and insurance as well as property taxes and insurance (PITI) plus recurring monthly costs for such things as auto loans, credit cards and student debts that are equal to as much as 43 percent of pretax household income.
For example, imagine that a couple has an annual income of $100,000. That's $8,500 per month. Forty-three percent of $8,333 is equal to $3,383.
Now suppose that they purchase a property. Their monthly cost for property taxes is $400 and they pay $100 monthly for homeowners insurance. If the rate of interest is 3.5 percent fixed over 30 years, the buyers will be able to borrow almost $335,000 with a monthly cost of $1,504 for principal and interest.If we add the costs of taxes ($400), insurance ($100) and the mortgage ($1504) the total is $2,000 per month. If as much is $3,383 can be spent each month for debt that means $1,383 is available for debt repayments even after considering the cost of housing.
|43% of Income:||$3,655|
|P and I:||1,504|
|Available for Debt:||$1,651|
The view here is that the new mortgage regulations can be seen in two ways:
First, it's good that the final guidelines allow individuals to borrow significantly against their income. Those who handle debt well, those who have solid credit on a long-term basis, will find a lot of space and flexibility in the new lending rules.
Second, the new regulations do not challenge or reduce current back-end ratios for conventional mortgage, FHA loans or VA financing – all are allowed. Instead, they effectively limit future loan programs which might permit higher back-end standards.
The new financial regulations take a lot of risk out of the mortgage marketplace while still leaving a broad range of financial options for both borrowers and lenders. That's a useful point of compromise and perhaps the reason why the lending community has generally been supportive of the new rules.