The new mortgage rules that are likely to affect your next home purchase

Correction: An earlier version of this report quoted David Zugheri, executive vice president of Envoy Mortgage in Houston, as saying that fees on an $80,000 mortgage would be capped at $2,400. Actually, the final version of the Consumer Financial Protection Bureau rule caps fees at $3,000 on qualified mortgages ranging from $60,000 to $100,000. This version has been corrected.


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December 13, 2013

If you’re planning to buy a house next year — and unless you’re in a position to make an all-cash offer — chances are you’ll be affected by some significant changes occurring in the mortgage application process beginning in January. 

Several federal agencies are implementing new policies aimed at addressing lax underwriting standards that led to the housing market crash more than five years ago. The new policies could play a role in how much house you can afford.

The policies require lenders to better verify that borrowers can afford the houses they are seeking to buy and can repay the loans. Some are intended to protect borrowers while holding lenders more accountable for their business practices.

For instance, one set of rules requires mortgage servicers to provide consumers regularly with accurate information about their loan balances and fix mistakes quickly. The rules also prohibit servicers from starting the foreclosure process until 120 days after the borrower’s last payment.

“By bringing back these basic building blocks of responsible lending and servicing the customer, we will improve conditions for consumers seeking to enter the market and for all those who are still struggling to pay down their existing loans,” Richard Cordray, director of the Consumer Financial Protection Bureau, said in prepared remarks made last week to the Consumer Federation of America.

“By making the mortgage market work better, we will build consumer confidence and strengthen this essential foundation of our economy,” he added.

Another big change affecting the Washington region is a Federal Housing Administration (FHA) plan to decrease the maximum loan amount for borrowers in this area beginning Jan. 1.

The agency announced this week that its mortgages will be limited to a maximum of $625,500, down from $729,750. Metropolitan Washington has high-priced housing — about one in four homes in the region sells for $600,000 and above, according to RealEstate Business Intelligence, a subsidiary of Rockville-based multiple listing service MRIS. The FHA’s new loan limit next year will match the caps for conventional loans purchased by Fannie Mae and Freddie Mac.

The FHA said in a statement that the agency wants to reduce the government’s role in mortgage lending to borrowers who are “underserved” — who either are low-income or have difficulty obtaining loans. The higher limits were put in as an emergency measure in 2008 and were supposed to last one year but were allowed to continue because of the lack of private loans.

Borrowers who need a loan of more than $625,500 will have to get a jumbo loan, which typically requires a down payment of at least 20 percent. FHA loans are not only a little more flexible in terms of their qualification guidelines, but, more important for many people, they require a down payment of just 3.5 percent.

“Switching on the fly from a down payment of 3.5 percent to 20 percent or more of the purchase price is not really an option for most people,” says Patrick Cunningham, vice president of Home Savings and Trust Mortgage in Fairfax.

“It could be a $100,000 difference in money needed,” Cunningham adds. “Not something most people just pull out of the couch cushions.”

Ability-to-Repay rules

On Jan. 10, the Consumer Financial Protection Bureau will implement a new set of rules designed to address predatory lending practices that spurred a wave of foreclosures the past five years.

Authorized by the Dodd-Frank Act, the “Ability-to-Repay” regulations are aimed at preventing lenders from approving mortgages for borrowers with questionable credit scores and poor debt-to-income ratios, and steering them into adjustable-rate loans or interest-only loans with little or no money down.

The housing crisis emerged in part when rates on ARMs were reset upward. Millions of homeowners who were not completely qualified for their mortgages lost their properties in foreclosure because they could no longer afford them.

The good news for borrowers is that the new rules will cap loan origination fees — they will be no more than 3 percent of the amount for mortgages of $100,000 and above. Currently, loan origination fees are not capped. However, to stay competitive, most lenders keep their fees low enough to attract customers yet high enough to make their business profitable.

The rules establish a standard for what the government considers a “qualified mortgage.”

Risky mortgages — negative-amortization, interest-only or balloon-payment loans — fall outside the qualified-mortgage standard.

Lenders will be required to thoroughly verify consumers’ income, assets and obligations — or otherwise risk a lawsuit from borrowers who default on their mortgages.

But while the regulations are intended to benefit consumers, some experts say that, like the Affordable Care Act, the changes may lead to complications and unintended consequences.

One example they cite is a provision in the rule that requires borrowers’ debt to make up 43 percent or less of their gross income.

“People who are right on the line of qualifying right now may not qualify in 2014” because of the policies set by Dodd-Frank, says David Zugheri, executive vice president of Envoy Mortgage in Houston.

In his prepared remarks, Cordray called it a myth that the new standard will prohibit lenders from issuing mortgages to borrowers who don’t meet the 43 percent debt-to-income ratio. Lenders, he said, would still have flexibility to make exceptions for buyers with excellent credit scores, significant assets or extenuating circumstances that make it difficult to verify income.

This “particular claim is wrong in three ways,” Cordray said. “First, lenders can also rely on the standards for loans backed by [Fannie Mae and Freddie Mac] or federal housing agencies. Second, smaller local creditors can make the same kinds of solid loans they have always made if they choose to keep those loans in their own portfolio, as they often have done in the past. Third, lenders can simply use their own judgment when looking at your ability to repay, just as they always have done.”

But some experts assert that lenders will be unwilling to make loans that don’t meet the qualified-mortgage standard. Because Fannie Mae and Freddie Mac won’t buy those mortgages, the lenders would be forced to keep them on their books.

More expensive mortgages?

Another criticism cited by some experts is that borrowers seeking conventional mortgages meeting the criteria of Fannie Mae and Freddie Mac may face higher fees.

Fannie Mae and Freddie Mac announced this week that guarantee fees they charge to lenders for servicing their loans will rise an average of 14 basis points on 30-year fixed-rate loans, on top of the 10 basis point increases in both December 2011 and August 2012.

Since lenders indirectly pass on the cost of paying the guarantee fees to consumers, Richard Green, director of the Lusk Center for Real Estate at the University of Southern California in Los Angeles, asserted that the change could have a negative impact on consumers’ ability to borrow money.

The fees charged to consumers used to be roughly 11 to 13 basis points, and now they are about 50 basis points, says Green. A basis point equals 1/100th of 1 percent, so 100 basis points would be equal to a one percentage point change in an interest rate. He says they could go as high as 70 to 75 basis points in the coming year or two.

Since borrowers are limited by qualified-mortgage rules to a debt-to-income ratio of 43 percent or less, higher mortgage rates and higher fees that increase the size of their housing payment make it more difficult for some borrowers to qualify for a loan.

Zugheri says that new regulations and higher expectations for compliance with rules established by Fannie Mae and Freddie Mac are hitting some groups of borrowers harder than others, such as low- to moderate-income consumers.

“If you have slightly spotty credit, your income isn’t clearly defined, your assets are hard to verify or the value of your home is difficult to appraise, you’ll have a hard time getting credit and you may not qualify at all,” Zugheri says.

Difficulties for the self-employed

Doug Benner, vice president and sales manager of 1st Portfolio Lending in Rockville, says the hard line requiring a maximum debt-to-income ratio of 43 percent will make it especially harder for self-employed borrowers who have trouble documenting their income.

“If you don’t have a W-2 to prove your income, it’s very difficult to get a loan, but the data shows that a larger percentage of the population is self-employed or doing contract work and they should be able to get loans,” Benner says.

Benner says loans with reduced documentation were a good fit for self-employed borrowers, but regulations have eliminated those programs. Benner says he knows of borrowers with high net worth, perfect credit and a home valued at $2 million with $1 million in home equity who were unable to qualify for a mortgage because they lacked the documentation to prove their income meets the debt-to-income ratio.

“It won’t get better, either, because state legislation in Maryland and the QM [qualified-mortgage] rules all say that borrowers need to prove their ability to repay a loan based on cash flow,” Benner says.

Zugheri says the bigger problem right now in the housing market is that overregulation and capped compensation mean that many lenders will drop out of the business. Ultimately, he says, less competition among lenders will lead to higher fees and higher mortgage rates, which will hurt the housing market and particularly affect low- to moderate-income borrowers who have a harder time affording a loan.

As the rule is written, Zugheri said, the most a lender can charge for a qualified mortgage ranging from $60,000 to $100,000 is $3,000, while the most it can charge for a $500,000 loan would be $15,000. “Some of the fixed costs are the same no matter what size loan you make, so some mortgage companies will just stop making smaller loans or will do fewer of them because they may even lose money on them.”

“The biggest issues that bite everyday people are rising guarantee fees, the difficulty of self-employed people to get a loan and the concern about loan buybacks,” says Green. “Unfortunately, nothing’s changing those things anytime soon.”

Michele Lerner is a freelance writer. Freelance writer Sheree R. Curry also contributed to this report.

So how will the new mortgage rules affect you?

FHA loan limit decrease: Buyers who need to borrow more than $625,500 will be unable to use FHA financing and must apply for a jumbo loan. Typically, this means that instead of making a down payment of 3.5 percent, borrowers will be required to make a down payment of at least 20 percent. The down payment for a $650,000 purchase would jump from $22,750 to $130,000 in that case.

Ability-to-Repay/qualified-mortgage rule: Borrowers without a lot of debt won’t be affected by this new rule, but those who have a debt-to-income ratio above 43 percent will find it harder to qualify for a loan unless they can reduce their debt or boost their income. Self-employed borrowers will need to provide more documentation of their income, and all borrowers will be required to provide extensive paperwork to prove their income and assets.

Caps on loan origination fees: Lender fees will be limited to 3 percent of the loan amount, which means borrowers won’t be overpaying for their loans. However, the cap on fees may make lenders less likely to offer smaller loans.

Rising guarantee fees: Lenders are likely to pass on higher fees that they pay to consumers, which will add to the cost of borrowing. That is on top of rising interest rates, which many experts are forecasting will reach at least 5 percent next year. While that’s not high in historical terms, rising borrowing costs mean that many people won’t be able to get as much house as they had hoped. Still, some experts see an upside: Higher rates may mean fewer loan applications in 2014. Tight competition between mortgage companies for a smaller pool of applicants could mean that lenders will loosen their standards a little and make it easier for some borrowers to qualify for a loan.

New mortgage servicing rules: Mortgage servicers will be required to provide each borrower with a monthly statement that clearly shows their interest rate, loan balance and escrow account balance and an explanation of how their payment is being credited. Lenders will be required to credit mortgage payments on the day they are received. “Dual tracking” will no longer be allowed, which means that no foreclosure proceedings can be started until a borrower is at least 120 days late and until borrowers have completed a loss mitigation application and it has been addressed by the lender.

— Michele Lerner

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