An analysis of home loans showed that 1 in 5 current mortgages would not meet the qualified mortgage safe harbor standard that goes into effect in January. Financial risk-management company ComplianceEase released a study highlighting the likely impact of the qualified mortgage, or QM, rule on the industry. The QM rule will require lenders "to make a reasonable, good faith determination of a consumer's ability to repay any consumer credit transaction secured by a dwelling," according to the Consumer Financial Protection Bureau. The rule also says that lenders who issue mortgages meeting the QM criteria have safe harbor, meaning they cannot be sued by borrowers claiming the loan terms are unfair.
There are four types of qualified mortgages under the Dodd-Frank Wall Street Reform and Consumer Protection Act, but in general, they preclude any of the following features: upfront fees or points greater than 3 percent of the loan; negative amortization; interest-only periods; loan terms longer than 30 years; and ballooning principals. A borrower's debt-to-income ratio must be 43 percent or lower, and the mortgage rate needs to be close to the national average prime mortgage rate (within 1.5 percentage points for first-lien loans and within 3.5 percentage points for subordinate-lien loans). A loan with a higher interest rate makes it a higher-priced mortgage.
Of the 1 in 5 mortgages originated today that don't meet the new QM standards, more than half of them have fees in excess of the 3 percent limit, and they exceed that limit by about $1,500. The rest of the loans that fall short do so because the mortgage rates are too high. "Based on current guidelines, these loans also will not be eligible for purchase, insurance or guarantee by government-sponsored enterprises (GSEs) or government agencies," said the news release announcing the company's analysis.
What the New Rule Means for Borrowers: Under a provision in the Dodd-Frank Act, lenders must verify a mortgage applicant's ability to repay the loan. Issuing a QM fulfills the ability-to-repay requirement, which is met by the lender confirming eight aspects of the borrower's finances with third parties: current or reasonably expected income or assets; employment status; monthly mortgage payment; monthly payments on simultaneous loans; monthly payment for mortgage-related obligations; other debt obligations, alimony and child support; debt-to-income ratio or residual income; and credit history.
The new QM thresholds take effect Jan. 10, 2014, which will not only impact lenders' liability, but also consumers' ability to qualify for home loans.
The new standards are intended to protect consumers from practices that spurred the financial crisis, and while it may be more challenging for those with poor credit to qualify for mortgages, there are steps consumers can take to improve their chances. Paying down debts will improve an individual's debt-to-income ratio and raise credit scores as a result. Credit history is a key component of a loan application, and consumers can get a better sense of their credit standing by reviewing their free annual credit report, and checking their credit scores using free online tools (such as Credit.com's free Credit Report Card).