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Borrowers and the New Mortgage Rules

Posted: 1/12/2013 3:08:00 PM
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The Consumer Financial Protection Bureau (CFPB) rolled out long-awaited new rules for residential mortgages this week. So what will be the impact on mortgage borrowers?

Like many newly released regulations, the full details are still being sorted out. However, in general it's going to be more difficult for marginally qualified borrowers to get a mortgage, while those who do get home loans will enjoy certain protections against excessive charges.

It's not yet clear whether the rules will make home loans more or less available in general. Some industry critics say that by imposing stricter standards for who can get a mortgage, the rules will put a crimp in lending. On the other hand, others say that finally having the rules in place eliminates uncertainty for lenders, while new liability protections will allow them to lend with confidence.

The crux of the new rules is to ensure that borrowers are only approved for mortgages they can afford - something that didn't always happen during the housing bubble. Toward that end, the CFPB has put forward an "Ability to Repay" rule that applies to all mortgages and standards for "Qualified Mortgages" that meet those guidelines.

Here's what borrowers can expect, first under the Ability to Repay rule, then for Qualified Mortgages.

Ability to Repay

Limit on total debt

Under the Ability to Repay rule, a borrower's total monthly debt, including mortgage payments and associated costs such as property taxes and homeowner's insurance, cannot exceed 43 percent of monthly income. There will be a seven-year phase-in period during which mortgages that exceed this limit but otherwise meet Fannie Mae , Freddie Mae, FHA or other government-backed underwriting standards will still be allowed.

Income must be documented

Lenders must verify that a loan applicant has sufficient income and assets to repay the mortgage. In other words, no more "liar loans" where a borrower simply signs a statement attesting to his or her financial status. This could present challenges for self-employed or certain high net worth individuals who have often relied on stated income loans in the past.

Long-term affordability

Lenders will not be allowed to assess a borrower's ability to repay a loan based on a temporary "teaser" rate - that is, an artificially low initial rate offered on a ARM. Instead, the lender must look at the borrower's ability to maintain payments over the life of the loan, based on current income and assets.

Qualified Mortgages

Home loans that meet the standards for Qualified Mortgages will be assumed to meet the Ability to Repay rule. Lenders who issue a Qualified Mortgage will enjoy certain protections against liability if the borrower eventually proves unable to repay the loan. Not all home loans will be required to be Qualified Mortgages, but the financial protections they offer lenders are expected to make them less costly and therefore dominate the mortgage market.

Limit on interest rates

The interest rate on Qualified Mortgages may not be more than 150 basis points (1.5 percentage points) higher than the base prime rate for that type of loan. In other words, if the base prime rate is 4 percent, the interest rate could be no higher than 5.5 percent for a Qualified Mortgage. Since high-risk mortgages tend to carry significantly higher rates, this will likely make it much harder for borrowers with low credit scores to get a mortgage.

Limit on points and fees

Qualified Mortgages will have a limit of 300 basis points (3 percentage points) on fees and points charged. Charging additional fees and points is another way lenders balance the risk of issuing mortgages to less qualified borrowers, so this is also intended to limit the availability of mortgages to high risk borrowers.

There is an exception for bona fide discount points, which borrowers commonly use to reduce their interest rate by a certain amount for every 1 percent of the loan amount paid upfront.

This rule could have a negative impact on mortgage brokers, who receive discounted rates from wholesale lenders and add back in a certain percentage as their fee. If so, that could limit borrowers' options for finding their best deal. This part of the rule may be modified to take this into account.

Ban on "toxic" features

Certain loan features that are considered inherently risky are not allowed on Qualified Mortgages. These include loan terms of longer than 30 years, interest-only payments, negative amortization (where the principle owed increases over time) and balloon payments.

Rules for high-cost mortgages

The new guidelines also include rules for high-cost home loans that do not meet the standards for Qualified Mortgages. High-cost mortgage loans are defined as those with interest rates more than 150 basis points (1.5 percentage points) above the average prime rate for purchase mortgages and refinancing, or 350 basis points (3.5 percentage points) for home equity loans.

This will likely affect jumbo loans, which carry higher interest rates than standard mortgages. Jumbo loans are defined as loan amounts in excess of $417,000 in most of the country, ranging up to $729,750 in counties with high home values.

These rules include:

Restrictions on balloon payments

Balloon payments will generally be prohibited on high-cost mortgages, although there will be an exception for loans in rural or underserved areas, where such loans have long been a staple of the mortgage market. Penalties for early payment will be prohibited.

Closing costs paid up front

The new rules prohibit closing costs from being rolled into the loan amount on high-cost mortgages.

Limits on fees

Late fees on high-cost mortgages will be capped at 4 percent of the amount due. Fees may not be charged for a loan modification and there will be a limit on the fees that may be charged for providing a payoff statement.

Counseling required

Borrowers will be required to undergo housing counseling before being approved for a high-cost mortgage.

Small lenders may handle risky loans

Homeowners deemed high-risk may still be able to get a mortgage by going through a credit union or small lender under the new guidelines. The CFPB is considering amendments that would grant Qualified Mortgage status to certain loans made by such lenders, provided that they keep the loans on their own books and do not sell them on the secondary mortgage market; that is, they continue to bear the risk for such loans.

The CFPB is still accepting feedback on the new rules and some modifications are still possible before they go into effect on Jan. 10, 2014.

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