New mortgage loan rules beginning on Jan. 10, 2014 could limit the current availability and cost of mortgage loans but experts state that the real impact is in the long-term.
The new lending rules are an amendment of Regulation Z of the Dodd-Frank Act. According to the Consumer Financial Protection Bureau, lenders must confirm that a borrower’s debt-to-income ratio is less than 43 percent.
In addition to the DTI ratios, lenders must also request and verify a borrower’s ability-to-repay via eight different categories :
Current income or assets
Current employment status
Monthly mortgage payment for current loan
Monthly payments for other mortgage loans
Monthly payments for mortgage-related expenses
Overall monthly debt payments including a debt-to-income ratio
The new rules could prevent some homeowners from gaining approval on a mortgage loan, but without the protections of these new rules, those homeowners would have likely received unfavorable lending terms.
Leading up to the housing crash, many borrowers put too much faith in lenders, relying on the underwriters to decide if they could actually afford and repay the mortgage debt. The lax standards during the early- and mid-2000s forced millions of loans into default or underwater status.
In the aftermath of the housing bubble burst, most lenders quickly enacted their own lending standards and required similar information verification for new mortgage loans. The current CFPB amendment is simply a reiteration of guidelines enacted after the housing crash by the main lenders, according to Tim Lucas, editor-in-chief of mymortgageinsider.com.
“After 2008, lenders did away with non-verified loans,” he said. “So in that way, the ability-to-repay rule is beating a horse that died long ago.”
Lucas said there could be a tangible financial impact of the rules. He said that buying a home in large cities could become more expensive. But for other areas with low home prices and high incomes, such as Texas, the lending market should proceed in a normal fashion.
The other component of the rule, the 43 percent debt-to-income ratio, could also have an impact on many consumers that take on large debts but are able to repay on time.
In 2006 and 2007, Lucas regularly approved borrowers with DTIs of 55 percent and even 65 percent. Despite the high numbers, he insists that the loans were not subprime and were allowable under Freddie Mac’s lending guidelines.
He is surprised that the debt cap was set at 43 percent instead of a higher figure.
“While debt ratios this high were arguably a bit excessive, there were usually compensating factors that made up for the high DTI,” he said. “Usually the borrower had great credit and a lot of money in the bank.”
Lucas predicts that retired consumers stand to be hit the hardest due to their limited monthly income.
FHA loan borrowers are able to avoid the DTI limit and apply for larger loans. Lucas said this exemption will push more new home loans into the more expensive FHA loan territory.
Aside from the FHA’s products rising in demand, David Reiss, professor of law at the Brooklyn Law School, said there could be other long-term effects due to this high DTI ratio since the lending rules will likely remain for several decades.
If the rules remain intact, the high DTI number can still be lowered at a later time. For instance, if few defaults occur when the bar is set at 43 percent, the limit might increase. Conversely, if a large number of defaults occur, the limit will decrease even further.
Reiss hopes that the agencies overseeing the rule will make these changes based on empirical evidence.
“I’m hopeful that regulation in this area will be numbers driven,” he said.
Despite the wording, Bill Parker, senior loan officer at Gencor Mortgage, said that lenders are technically “not required to ensure borrowers can repay their loans.” He said lenders are legally required to make a “good faith effort” for reviewing documents and facts about the borrower and indicating if he or she can repay the debt.
“If they do so, following the directives of the CFPB, then they are protected against suit by said borrower in the future,” Parker said. “If they can’t prove they investigated as required, then they lose the Safe Harbor and have to prove the borrower has not suffered harm because of this.”
The statute of limitations for the CFPB law is three years from the start of loan payments. After that time period, the lender is no longer required to provide evidence of loan compliance.
Even though the amendment could impact the current lending market, experts told loans.org that the CFPB’s standards will make a greater impact on the future of the housing industry.
Reiss believes that the stricter rules will create a sustainable lending market.
Lucas agrees and thinks of the rules as more preventative measures.
“The idea was to put a fence at the edge of a cliff so lenders would not eventually fall off again,” he said.
Although the thought of approving a loan without income verification sounds ludicrous now, it was not always this way. Lending rules and debt caps were common in the 1990’s, but as the new millennium began, the rules became less common. The CFPB’s rules ensure that future mortgage lending is protected.
“History teaches us that as time goes by we really don’t learn from our mistakes,” Lucas said.