It may be a little bit tougher now for more marginal borrowers to qualify for home mortgages than it was just a few weeks ago. That’s because a series of new rules became effective on Jan. 10 that require lenders to take greater care that their borrowers can actually afford to pay back their qualified mortgages. We first looked at these mortgage rules a year ago.
In a nutshell, the new 800-page regulation defines the following requirements for qualified mortgages:
- Points and fees must amount to not more than 3 percent of the loan.
- Terms are capped at not longer than 30 years.
- Loan payment must have a debt-to-income ratio of 43 percent or less of pre-tax income.
- Creditors must use a “reasonably reliable method” to verify an applicant’s stated income.
- Qualified loans cannot have negative amortization and cannot be interest-only loans.
Meanwhile, for applications dated Jan. 10, 2014 or later, creditors must take into account at least these eight underwriting factors:
- Current or reasonably expected income/assets.
- Current employment status.
- Monthly payment on the loan applied for.
- Monthly payment on any other loans applied for.
- Monthly payment for all mortgage-related debts.
- Other current debts, including child support and alimony.
- Monthly debt-to income-ratio and/or residual income.
- Credit history.
What is the likely effect going forward, now that the new rules are coming on line?
First of all, some smaller lenders are signaling that they will be more cautious going forward with making nonqualified loans. At least one lender, Michigan Mutual Inc., has indicated to the Wall Street Journal that “we’re going to be very conservative just to make sure that we’re in compliance and don’t get into trouble.” Their CEO, Mark Walker, continued in the interview: “There were loans that we did in 2013 that we are not going to be able to do in 2014.”
Other smaller lenders are chafing under the new requirements, complaining of lack of flexibility. Smaller lenders tended to know their borrowers better during the boom, and so experienced lower default rates during the bust. But they are being treated as if they were part of the problem, according to some of their spokespeople. ““I’m not the problem they’re trying to fix, but they fixed me anyhow,” Jack Hartings, chief executive of the Peoples Bank Co. in Coldwater, Ohio, told the Wall Street Journal.
“Credit unions didn’t cause the financial crisis and shouldn’t be caught in the crosshairs of regulations aimed at those entities that did,” said Daniel Weickenand, CEO of Orion Federal Credit union, recently testifying on behalf of the National Association of Credit Unions before the House Financial Services Committee. “We are concerned that this rule will potentially reduce access to credit and hamper the ability of credit unions to continue to meet their members’ needs.”
The effect the new rules have, if any, will likely be most pronounced in markets like New York City, San Francisco and Honolulu, where high property values drive a disproportionate number of home prices above the Fannie and Freddie “jumbo loan” threshold. Currently, the jumbo loan threshold is $417,000 for single-unit homes, though in select markets it can go up to $625,500.
At the same time, the cap for FHA loans for high-cost markets actually fell, effective Jan. 1, to $625,500.
If there is any negative effect on home prices as a result of the rule change, it will show first in these markets, and specifically in the higher-priced neighborhoods. Above the Fannie/Freddie/FHA thresholds, loans will not be considered “qualified mortgages.”
The market for smaller mortgages could also be substantially affected. The issue: the 3 percent cap on fees. Because processing a mortgage has certain fixed costs regardless of the size of the loan, the 3 percent cap is a substantially greater burden for an 80,000 to $120,000 loan than it is for a jumbo mortgage.
We could see capital devoted to these very high-priced or very-low-priced markets decline if lenders shy away from nonqualified loans in these segments. This would have, in theory, a negative effect on home prices in these markets.
Meanwhile, in conforming markets for homes below the Fannie/Freddie jumbo threshold, but about $150,000 or so, we should see little effect. The real estate industry’s substantial lobbying power successfully fended off efforts to impose any kind of significant minimum down payment. So while lenders do need to make a pro forma effort to verify income (no more NINJA loans, thank goodness!), outside of the requirement that qualifying mortgages amortize over no more than 30 years, there is still no minimum skin-in-the-game requirement for Fannie and Freddie loans. Local lenders can still impose more stringent criteria.
The 43 percent payment-to-income ratio, on the other hand, indicates just how far we have come. A generation ago, the general guideline to families was to spend not more than 25 percent of gross income on housing costs. And top limits of 35 percent were not uncommon. Now families are routinely bumping right up against the 42 and 43 percent threshold – and bidding home prices up accordingly – though against incomes that have been largely decimated by the slow economic times of the last six years.
As the graph above shows, the median household income has fallen substantially since hitting its peak in 2001 and again in 2008 (buoyed, admittedly, first by the Internet bubble and then by the real estate bubble and wealth effects).
And median household income has stayed stubbornly low, despite one “recovery summer” after another.
Meanwhile, real estate prices have recovered strongly over the last 18 months, boosted by increasing rent levels, yes, but that benefits investors, mostly, and does not directly benefit owner-occupants. (Yes, they get to sell at a higher price, but then they still have to live somewhere, so it’s a wash!)
The broad increase in home prices cannot be explained by a concurrent increase in median income. The house price recovery comes at the cost of increased pressure on new buyers.