On January 10, 2014, new regulations of the Dodd–Frank Wall Street Reform and Consumer Protection Act (“Dodd Frank”) will become effective that restrict the underwriting guidelines for mortgages guaranteed by federal mortgage backers Fannie Mae and Freddie Mac.
Adopted in 2010, Dodd Frank is a set of financial reforms designed to “promote the financial stability of the United States by improving accountability and transparency in the financial system…[and] to protect consumers from abusive financial services practices…” Dodd Frank requires creditors for residential mortgages to make a reasonable and good faith determination based on verified and documented information that the proposed borrower has a reasonable ability to repay the loan according to its terms.
The legislation also established a presumption of compliance with this requirement for a certain category of mortgages, called “qualified mortgages.” A qualified mortgage is a home loan that meets certain standards set forth by the Consumer Financial Protection Bureau (“CFPB”) an independent federal agency created by Dodd Frank.
The qualified mortgage rule requires lenders to analyze at eight specific factors to determine a borrower’s ability to repay a mortgage. Those factors are:
- Salary and Assets
- Current Employment
- Credit Reports
- Mortgage Payments
- Monthly Payments on Additional Mortgages
- Additional Homeownership Expenses
- Other Liabilities
- Debt-to-Income Ratios
Debt to income ratio (“DIR”) is the percentage of an individual’s monthly income that goes toward paying debts. Beginning on January 10, 2014, in order for a mortgage to qualify, the proposed borrower’s DIR must not exceed 43% of their total income. Consider this example:
Bill makes $96,000 a year and would have monthly expenses of $5,000, under his proposed mortgage. John only makes $60,000 a year, but would only have $2,000 in monthly expenses with his proposed mortgage payment.
Even though John makes less money than Bill, his mortgage could be qualified because his DIR is less than 43% and Bill’s is not. Bill’s DIR would be 62.5% ($5,000 (expenses) / $8,000 (monthly income). John’s DIR would only be 40% ($2,000 (expenses) / $5,000 (monthly income).
Many critics of the new qualified mortgage rule believe it will disqualify many potential home buyers and force them to take out non-qualified mortgages. This, in turn, would lead to lenders being unwilling to take on the increased risk of borrowers with higher DIR’s or making the mortgages more costly.
In a letter sent to CFPB Director Richard Cordray, several industry organizations claimed, “Most economists and housing market analysts in government and in the private sector agree that today’s underwriting standards are tight and are contributing to a slow housing recovery…an unnecessarily narrow definition of QM…would undermine prospects for a housing recovery and threaten the redevelopment of a sound mortgage market…”
The mortgage application process can be one of the most stressful and complex steps in the purchasing of real estate. If you have questions regarding steps involved in the purchase of real estate, or need additional information about real estate transactions, contact the experienced real estate attorneys at The Slater Firm, Ltd. today.