2014 Mortgage Restrictions

Oh where, oh where has the happy medium gone? After mortgage lenders spent years tossing mortgages to anyone with a pulse, now the rules have swung to the other extreme, preventing many who can afford homes from qualifying for a mortgage.

The old system permitting mortgages to unqualified, sub-prime borrowers clearly needed to be retooled. At the height of the housing bubble, stated income was good enough, never mind having to prove you could handle the payments.

But the Consumer Financial Protection Bureau commissioned with the retooling may have tightened the bolts a little too hard, imposing a debt-to-income ratio of 43% among other restrictions. Private research firms estimate that from 10% to 50% of home buyers who qualify for mortgages under current standards will be shut out of the housing market when the stricter rules take effect on January 10^th, 2014.

“The pendulum has swung from way too crazy to too conservative,” scorned senior economist at CoreLogic, Sam Khater, to U.S. News and World Report.

Who will be affected most by these new mortgage restrictions? What can they do to get back into the housing market? Might there be a benefit to investors in all of this?

Better, But Still Not Good

To prevent the lax lending practices that inflated the housing bubble, regulators in 2011 proposed a plan requiring banks and other mortgage providers to retain a partial stake in the mortgages they issued. With part of each mortgage tethered to them, lenders will think twice before issuing loans to unqualified buyers, which they used to dump onto an unsuspecting market before slapping their hands clean.

In that 2011 proposal, only certain mortgages – known as Qualified Residential Mortgages (QRMs) – could be issued with no strings attached to the lender. If a mortgage has a cash down payment of at least 20%, with a debt-to-income ratio of not more than 36%, it would qualify as a QRM, and the lender would be able to issue the mortgage without having to hold a stake in it. Mortgages that failed to meet those qualifications would be considered more risky and would require the lender to retain partial ownership.

But the banks complained that their stake in those riskier mortgages would tie up their money for years, forcing lenders to concentrate their lending on just those applications that qualified as QRMs. This would, in turn, slow the housing recovery by severely limiting access to capital for home buyers who do not have a 20% down payment and for lower-income earners who do not meet the 36% debt-to-income limit.

So just last week, a new proposal was announced to lighten the load on the lenders and at the same time expand mortgage qualification to lower-income earners. They adjusted the criteria qualifying a mortgage as a QRM by eliminating the down payment requirement completely and raising the debt-to-income ratio to 43%.

Lenders could still approve mortgages that do not qualify as QRMs, but they would be required to retain a 5% stake in them and would also forfeit legal protection against failed loans.

David Stevens, president of the Mortgage Bankers Association, applauded the regulators before the Washington Post for recognizing “that the [2011] proposal would have unduly constrained the availability of mortgage credit for many borrowers,” and for re-proposing “a much better rule.”

Better for Whom?

Indeed, it is a better rule for the lenders, as they can now lend to more home buyers under a widened QRM classification, with all the legal protections in place. But it is not better for as many buyers as regulators would have us believe.

U.S. News and World Report cites concerns by Jordan Roth, senior branch manager of GFI Mortgage Bankers, a New York-area housing lending firm, who foresees that “some of the stringent guidelines are going to mean that some very qualified borrowers will be turned down.” And Charles Dawson, a National Association of Realtors specialist on housing finance policy, worries that “it could turn lending into a cut-and-dried question about income,” even where the buyer can afford the payments.

Those who would be shut out of the housing market are first-time home buyers who still carry college loans, since these are counted when calculating the debt-to-income limit. (Isn’t the young couple fresh out of college the quintessential image of new home buyers? Not anymore.)

It also shuts-out those who lost jobs over the past five years. (In this recession? There’s a few million crossed off the list right there alone.)

Even small business owners and independent contractors are out of the running for mortgages, since their incomes fluctuate. (So they have it together enough to be self-enterprising and create jobs for themselves and others, and in so doing are somehow disqualified for a mortgage?)

The CFPB admits the new proposed rules would reject more mortgage applicants than before, but the total number of those rejected would grow by only 10%. Others criticize that even one person or family who can afford a mortgage but is rejected all the same is one too many.

Not all people have the same spending habits. If a family or individual has managed to cut expenses considerably by not dining out as much, or by using public transportation instead of owning a vehicle, or have an additional part-time home-based business that brings in extra income, they could comfortably afford mortgage payments that are well above 43% of their income.

While acknowledging that “there may be instances in which consumers can afford a debt-to-income loan above 43 percent,” the CFPB “argues that it is carrying out its Dodd-Frank legal mandate by providing ‘bright lines for creditors who wish to make qualified loans,’” cites U.S. News and World Report.

The new restrictions are intended to attract more private investment into the mortgage market, as government sponsors Fannie Mae and Freddie Mac want to transfer more of the mortgage burden to the private investment sector. And the new rules would protect those creditors and investors from excessive risk.

If you’re an entrepreneur looking to get into the mortgage lending business, or an investor thinking about picking up some mortgage backed securities, your risks will soon be greatly reduced.

Home Buyers Can Persevere

But what if you are a home buyer who will soon be shut out of the market by the new mortgage requirements? One who can afford the monthly mortgage payments, but can’t qualify for a mortgage because it amounts to more than 43% of your income?

Keep saving your money and build up a large down payment, for starters. Even though the down payment requirement will be eliminated from the QRM qualifications, you can still slap down a cash payment voluntarily. The greater your down payment is, the lesser the amount borrowed will be, and the lower your debt-to-income ratio will be. You’ll likely even get a better interest rate.

You may also consider buying a smaller, cheaper home for now. It may not be your dream home, but it will save you from tossing rent money out the window. Getting into something cheap will build up equity as your rent is invested in your own property instead of your landlord’s.

In a few years, presto – you’ll have equity in your small shack, with extra value from rising prices over the years. You can then sell your starter home, buy your intermediate home, and set your sights on your dream home next.

The nation and the world are going through huge changes as a result of the recent housing and debt crisis. Regulators will keep coming out with tougher rules that are always broader than we’d like and cruder than is fair. But you can adapt by making changes that keep up with theirs.

Remember, there is one thing regulators can never change: your resolve. Show them you have an answer to everything they toss at you.

Joseph Cafariello

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