Heads up for mortgage borrowers: New rules that go into effect Jan. 10 hold lenders to stricter guidelines for ensuring potential homebuyers are qualified and able to repay their mortgages.
Why the rules were written
Implemented by the Consumer Financial Protection Bureau, the rules are part of the Dodd-Frank Act. These ability-to-repay regulations are aimed at protecting borrowers from the types of predatory lending practices that led to the huge scale of loan defaults and contributed to the housing crash. Part of the housing crisis was fueled by borrowers who found themselves stuck with unaffordable mortgages after rates on their adjustable-rate loans reset upward. Many lost their homes to foreclosure.
Under the new rules, lenders will have to ensure that borrowers are qualified through a set of guidelines that includes verifying their income, debts and assets.
Put a cap on it
As part of the same ability-to-repay mandate, origination fees will be capped at 3 percent of the amount for any mortgage of $100,000 or more. Origination fees have not previously been capped, although most lenders stay competitive by keeping them low.
Debt-to-income ratio reduced
While the ability-to-repay regulations appear to benefit the housing recovery on the surface, says Don Frommeyer, president of National Association of Mortgage Brokers and a senior vice president for AmTrust Mortgage Funding Inc. in Carmel, Ind., potential homebuyers still face economic headwinds in high unemployment and rising interest rates. On the whole, the housing market is improving and buyers are seeking mortgages while rates are still in the 4 percent range. "It's still a good time to buy a home," he says.
But one of the new regulations will particularly affect some borrowers' ability to obtain a mortgage or refinance, and that is that the debt-to-income ratio for a qualified loan must be 43 percent or less.
Fannie and Freddie routinely go higher than 43 percent
In the past, many lenders adhered to a debt-to-income ratio of 36 percent at most, meaning all debts, including housing, shouldn't exceed 36 percent of income. But under Fannie Mae and Freddie Mac rules, for instance, loans with up to 45 percent of debt-to-income could be automatically approved. The new, lower percentage will adversely affect some borrowers.
Rule means less flexibility
"In reality, borrowers have always had to show income and an ability to repay a loan," says Frommeyer. "That's not the tough one. The percentage (debt-to-income ratio of 43 percent) is the tough one. Sometimes, 44 percent makes sense for a borrower, or even 46 percent, but that won't be considered a qualified mortgage under the new rules. When you add all your debts, 44 percent is not far out of the realm of possibilities."
Calculate your debt to income
For potential buyers, especially first-time homebuyers who typically stretch their finances to get into a home, it's important to pay down debt before seeking a mortgage and to stay within the allowed debt-to-income ratio. This Bankrate calculator provides an easy way to figure the ratio. If you are a potential homebuyer, estimate your future housing costs in with your current debt to get an accurate picture and see if you are within the new limits.
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