Consumer Financial Protection Bureau logoBanks are talking about it, Credit Unions are talking about it, Loan Officers are talking about it, heck even the President and wanna be President are talking about it. Not too many people know exactly what it is and how it will pan out – but one thing is for sure, it definitely has the potential of derailing the nascent real estate recovery. As part of implementing the Dodd-Frank act, Consumer Financial Protection Bureau (CFPB) plans to finalize the rule for  “qualified mortgage (QM)” in January 2013. This proposal is the first ever attempt at defining and establishing a basic standard for qualifying borrowers for mortgage loans.

This provision is expected to establish general set of standards about a borrowers ability to repay a mortgage. This could include creating rules around Debt-to-income (DTI) ratios, employment status etc. Loans that qualify as “Qualified Mortgage” may get a full legal shield from the CFPB mandating that judges rule in lenders’ favor if the borrowers contest foreclosures. It would also establish rules on what kind of mortgages will qualify as “sub-prime loans” and hence would require more scrutiny and less legal protection for the lenders. Some of the proposals being considered are:

  • Cap DTI at 43% for qualified mortgages. Currently Fannie Mae and Freddie Mac allow 45% DTI and FHA/VA allow even higher. And if CFPB finalizes the DTI at 43% expect the lenders to allow a lower ratio say 41%. Lenders do this to allow room for underwriter error.
  • Loans at 1.5% over prime rate would be labelled sub-prime mortgages.

What could be the possible impact of this rule?

Borrowers may qualify for lower loan amount – If you currently make $10,000 a month and 45% DTI is allowed, your current plus future housing debt obligation can be $4500 a month. But if the DTI is capped at 43%, your debts can’t exceed $4300 a month. So if earlier you qualified for a $400k loan, a reduction of $200 in monthly allowed obligation will reduce your loan qualification down to $358k, a reduction of $42,000 in loan amount.

Crimp Low Downpayment Lending – FHA loans allow as little as 3.5% down payment and VA loans have no down payment requirement at all. They even allow higher DTI ratios. If the QM rule will restrict the DTI to 41% or 43% that would impact a lot of First time Home Buyers who are dependent on these loan programs and often have higher DTIs than 43%.

Without a clear definition in place now, “the uncertainty on rules and regulations is causing lenders to pull back out of fears of making a mistake,” says David H. Stevens, the president and chief executive of the Mortgage Bankers Association. “It’s causing lenders to keep standards tight because they don’t know what risk they’re taking until the final rule is complete.”

A combination of above policies will mean a much reduced pool of buyers. Some of them wont qualify at all while some others will qualify for much less house that they can right now. True impact can’t be gauged till CFPB implements the final rule, but the uncertainty around the rule is already making lending and real estate industry nervous.

I wil be tracking this very important piece of regulation and will be blogging regularly about it. So come back often to check what’s the latest on this or send me an email.

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