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Qualified Changes Approach the Mortgage Market

The "Qualified" Changes Are Creating New Rules To Play By

The “Qualified” Changes Are Creating New Rules To Play By

If you’re a consumer wondering what’s going to happen to the mortgage market next year, you’re not alone — there are a lot of changes in the works, and many of those changes are still changing. Here’s a brief rundown laid out as clearly as we can manage:

The Qualified Mortgage Rule

The Qualified Mortgage rule, or QM, is a set of underwriting rules laid out by the Consumer Financial Protection Bureau (CFPB). It’s broken into two parts.

The first part simply says that banks must actually examine a borrower’s finances and prove that they’re able to pay back the loan before they make it. This seems like a no-brainer, but there were lots of banks that weren’t doing that. It effectively eliminates ‘no-documentation’ loans by requiring that a bank documents its proof of repayment-ability. It does not, however, provide any actual standards for what ‘able to pay back’ means. It simply tells banks where to look and what to record.

The second part defines a “qualified mortgage” and gives extra legal protections on lawsuits involving qualified mortgages. In order to be a “qualified mortgage”, a given loan must not have:

  • Terms longer than 30 years
  • Balloon payments
  • Negative amortization
  • Fees and points that cost more than 3 percent of the loan, or
  • A borrower with a debt-to-income ratio above 43 percent. In other words, the borrower’s total monthly debt load, including car payments, credit card payments, alimony, and all other debts, cannot exceed 43% of his or her gross income after the estimated loan payment is counted in.
  • A rate at or above the prime interest rate

If a given mortgage meets all of those requirements, the lender is essentially “presumed innocent” of predatory lending charges. A borrower would have to first prove in court that a mortgage wasn’t actually qualified before they could bring predatory lending charges against the bank.

The Qualified Residential Mortgage Rule

Despite the naming similarity, this is a completely different entity than the above. The QRM rule isn’t created by the CFPB, but rather by a brace of regulators created by the Dodd-Frank Act. The QRM rule isn’t so much a rule as an exemption. Under the Dodd-Frank act, any lender who makes a loan is only allowed to sell 95% of that loan to another entity; they’re not allowed to pass on “all” of the risk inherent in lending. The theory is that by having some ‘skin in the game’, banks will be less likely to make silly loans, because they always retain “some” risk.

The QRM rule is an exception to the 5% law, that essentially says “if a mortgage is adequately secure, you can sell 100% of the risk inherent in that mortgage to another entity.” Initially, to qualify as a QRM, a mortgage had to have a 20% or greater down payment and the borrower had to have a debt-to-income ratio (see above) of no greater than 36%.  In the past few days, however, regulators decided that those standards were too strict. They changed the debt-to-income ratio restriction to 43%, matching the QRM standards to the QM standards. Word on whether or not they’re keeping the 20% down payment rule hasn’t been established.

Between the QM and the QRM you can look forward to a near-universal policy of lenders only giving mortgages out to borrowers whose debt makes up only 43% or less of their income. What effects that will have on the market remain to be seen, but at least the two big agencies got their acts together enough to settle on a single number. That will keep things much simpler for the lenders.

Stay posted for further changes. These rules aren’t yet set in stone.

Scott Storace

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