Shopping for a Mortgage: Beware of the Buffers

Some strange new terms are beginning to impact mortgages, so don't be surprised if your lender starts talking about buffers and buffering. Nope, we're not talking about the machines used to clean floors or the process required to shine shoes. Buffers and buffering are new terms that impact your ability to get home loans in at least two ways.

Buffers and Home Loans

If you've ever driven on a street which is famous for radar traps and speed cameras, you know that a little caution can keep you out of trouble. Many lenders have adopted the same approach when dealing with today's loan requirements.

Under Wall Street reform, lenders can make qualified mortgages (QMs) or loans which are not qualified mortgages -- non-QMs. Most loans today are low-risk QMs, and one result is plummeting foreclosure rates. RealtyTrac reports that February foreclosure levels were the lowest in seven years.

Lenders want to make QMs because such loans are virtually immune from lawsuits, a big deal for lenders who have recently paid out more than $100 billion to settle claims that past originations were allegedly misrepresented, substandard and even fraudulent. The catch is that to be considered QMs, mortgage loans must meet certain standards. Two of those standards can involve buffering.

Home Loans and Fee Limits

A major requirement under the Dodd-Frank mortgage reforms is that fees and points for most loans of $100,000 or more are limited to three percent of the loan amount. Go over the three-percent limit and the loan is non-QM financing, a type of mortgage with much more liability for lenders as well as higher costs for borrowers.

Most loans today are qualified mortgages, and many lenders want to be absolutely sure they have met the three percent standard. How? By having points and fees which are less than three percent of the mortgage amount.

A study by the National Association of Realtors shows that 52.6 percent of all lenders will go to the limit on fees and points and charge the full three percent allowed by the rules. However, that also means at least 47 percent will charge less to make absolutely, positively certain they do not break the rule. According to NAR, a large number of lenders are creating a buffer -- charging less than the allowable three percent -- to assure that they do not go over the new limit. Here's how the proportions shake out:

  • No buffer -- will charge the full 3.0 percent if possible -- 52.6 percent of all lenders.
  • Some buffer -- not more than 2.9 percent -- 10.5 percent of all lenders.
  • A bigger buffer -- not more than 2.8 percent -- 15.8 percent of all lenders.
  • A mega buffer -- not more than 2.7 percent -- 5.3 percent of all lenders.
  • A super-sized buffer -- not more than 2.6 percent -- 15.8 percent of all lenders.

The Bottom Line: It pays to shop for financing because some lenders are charging significantly lower fees. On a $200,000 mortgage the difference between points and fees of three percent and points and fees of 2.6 percent is $800. Keep in mind, however, that lower fees could mean higher rates -- look over the entire quote to make a meaningful comparison.

Home Loans and the 43-percent DTI

While the use of buffers and buffering benefits borrowers when it comes to points and fees, the result is different when it comes to debts and income.

Under Wall Street reform, borrowers generally cannot use more than 43 percent of their gross monthly income for housing costs and other recurring debt. The 43-percent debt-to-income limit, or DTI, is actually a consumer protection -- and a lender protection as well -- because it's designed to stop borrowers from taking on excess debt that can lead to foreclosure.

While points and fees are costs which can be easily determined by lenders, the same is not true with borrower expenses. Undisclosed debts are a serious worry for lenders; a 2013 Equifax study showed that almost one-fifth of all mortgage applicants applied for new credit while trying to qualify for a home loan. "Many borrowers," said Equifax, "simply don’t realize how this new 'undisclosed debt' impacts their ability to qualify for their mortgage."

Undisclosed debt is a problem for two reasons:

First, if you're a borrower, it means that when undisclosed debt is found, the lender will have to re-calculate your ability to qualify for a mortgage. This will slow down your loan application and in some cases derail it altogether.

Second, undisclosed debt may put you over the 43 percent DTI limit, and that's a huge problem for the lender -- what used to be a qualified mortgage is now a non-QM loan and suddenly the lender can face big liabilities.

To deal with the hidden debt issue, the NAR found that some lenders will not qualify borrowers with a 43-percent DTI -- or anything close. More than 20 percent will not allow DTIs above 40 percent.

This is hugely important to borrowers. Check out this example to see why: The Smiths earn a monthly income of $6,000. If they can devote 43 percent of their monthly income to recurring debts such as housing costs, auto loans, student debts and credit card bills, they can spend as much as $2,590 per month on such costs. If the allowable DTI is 40 percent, then the ceiling on monthly debt payments is $2,400. The $190 difference means that borrowers who qualify for financing with a 43 percent DTI will not get financing at 40 percent.

The lesson -- again -- is that borrowers must shop around to get the best deals. Ask lenders about buffers and buffering and how they handle the points-and-fees limitation as well as DTI restrictions.

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