As anticipated, new mortgage lending guidelines went into effect on January 14, 2014. Drafted by the new Consumer Financial Protection Bureau (CFPB), the new rules are designed to protect consumers from the type of lending practices that triggered the real estate crash of 2008, which in turn hastened the worst recession of our lifetime.
The big question, is how the new guidelines will help or hurt the average real estate buyer, and how they might protect the economy itself from another mortgage crisis.
First, most lenders don’t seem overly concerned about new restrictions, given that many of the suggested practices have already been phased on over time. In fact, the Dodd-Frank Wall Street Reform and Consumer Protection Act which was enacted in 2010, laid the groundwork to the new CFPB rules. Dodd-Frank requires lenders to more diligently inspect would-be borrowers' financial information to make sure they can afford a loan.
Also, most banks have already been self-policing for years now, using more stringent guidelines than in the past. Still, there are lenders who are concerned that tighter rules will make it more difficult for lower-income (and in some cases, even average) buyers to purchase homes.
CFPB director Richard Cordray took a pragmatic approach, however, during a hearing on Friday, February 14, when he stated: “No debt traps. No surprises. No runarounds. These are bedrock concepts backed by our new common-sense rules, which take effect today.”
There are a couple of major categories that mortgage lenders are being asked to comply with.
One, is the Ability to Repay rule. Here, the lender uses a number of guidelines to establish a borrower’s ability to make payments throughout the life of the loan. Important criteria include debt-to-income ratio, including all monthly obligations such as car and credit card payments, utilities, student loan payments, living and other recurring expenses, and dividing this total by an applicant’s monthly gross income.
The second big rule is the “Qualified Mortgage” guideline, which prohibits interest-only loans, terms longer than 30 years and balloon payments. There’s also a 3 percent test rule for properties being resold into the secondary market. In this case, 3 percent represents the maximum amount of fees that can be charged by the mortgage broker which poses challenges for home sales below $160,000, given that all origination fees, including broker fees, have to be absorbed into this percentage.
Also worth noting is the debt-to-income ratio for Qualified Mortgages which must generally be less than 43 percent. This isn’t absolute—banks can find ways to adjust the criteria, such as a high level of assets. Overall, however, these new guidelines intended to prevent buyers from getting in over their heads. And, while this trend has been building since the fallout from the subprime crisis, the CFPB rules definitely have some teeth.
As for low-to-moderate income borrowers who are unable to meet the stricter new guideline, there are some alternative lending programs, such as community development financial institutions, state and local government housing finance agencies, and HUD-designated payment assistance creditors. Also, some local banks are able to offer Qualified Mortgages without a debt-to-income limit.
Additionally, HUD is asking for a separate Qualified Mortgage standard for FHA loans that will be exempt from the debt-to-income limit, in order to continue the housing department’s commitment to serving lower-income borrowers.
The protections against a repeat of the subprime-instigated crisis are obvious with the new guidelines. As for any possible cooling effect on the real estate market in Washington Metro, that remains to be seen. Property values in many parts of the region have jumped dramatically in recent years. Could upper middle class buyers find themselves in a crunch when pursuing upscale properties? Could there be an increased trend toward outlying suburbs or less desirable neighborhoods? Only time will tell.