In response to the Dodd Frank Wall Street Reform and Consumer Protection Act, new mortgage laws will take effect on January 10, 2014.
If you’re in the market for a new home, or planning to refinance in 2014, here’s what you need to know.
The Qualified Mortgage Rule
The Qualified Mortgage rule places new limitations on loan terms and lender fees, and it requires more thorough income and debt verification. The rule will eliminate the potential for unfair lender practices like balloon payments and reverse amortization. Under most qualified mortgages, lenders will be limited to charging fees no greater than 3% of the total loan amount.
These provisions prevent lenders from taking advantage of consumers, but there’s something in it for them, as well. Most lenders will be eager to comply with the Qualified Mortgage rule, because it’ll provide them with legal protection. As long as their practices comply with QM rules, they’ll be much less vulnerable to losing money on lawsuits, which are a major expense for mortgage lenders.
Even though the act will encourage more sound and fair practices among mainstream mortgage companies, it doesn’t necessarily mean that mortgages will be easier to get.
Here are two factors that will play a big role:
1. Your “Ability to Repay”
Qualified Mortgages will also require solid verification of the consumer’s income, assets, and current level of debt. Although this is included in Qualified Mortgages, it’s listed as a separate rule.
This practice should be standard already, but many lenders abandoned the verification process in favor of acquiring more mortgages, which contributed to the market’s downfall. Now lenders will be required to examine eight specific criteria to determine a person’s eligibility for a loan.
This will involve documentation — and not simply word-of-mouth verification. One part of this verification process involves the consumer’s debt-to-income ratio.
2. Your New Debt-to-Income (DTI) Ratio
Debt-to-Income Ratio is the percentage used to determine whether a potential homeowner will be able to handle the new financial obligation of a mortgage payment. The number is reached by dividing your total debt (anything you’re currently making payments on) by your gross monthly income.
According to the Qualified Mortgage rule, the new limit for DTI is 43%. If you’ve never owned a home before, this number probably doesn’t mean anything to you. But those who know the mortgage industry will realize this is at least 2% lower than the average DTI requirement of major lenders like Freddie Mac.
What This Means for the First-Time Buyer
The new 43% DTI requirement means that people who would’ve qualified for a mortgage in the past may exceed the new DTI and be forced to delay their purchase of a home. While this isn’t going to provide an immediate boost for the housing market, it’ll hopefully create fewer defaulted mortgages.
If you’re turned down for a mortgage because your debt-to-income ratio is too high, you need to decrease your debt or increase your income.
The easier of these two is to decrease your debt. Concentrate on paying off large short-term loans, such as car loans and credit cards. The smaller your debt, the lower your DTI ratio and the more likely you are to qualify. Of course, you can also opt to save more cash for your down payment, which will decrease the loan amount and your projected monthly payments.
What This Means for the Refinancer
Those looking to refinance may also have a problem with their DTI under the new rules. The best options for those refinancing are to pay down more debt before refinancing, or consolidate. If your finances can’t handle a higher payment, you should never try to manipulate your DTI just to get approved .
Whether you’re buying or refinancing, be prepared for the new mortgage laws by checking and adjusting your own DTI ratio and paying off as much debt as possible.
Are you considering buying or refinancing in 2014? Were you aware of these new laws?