As the real estate industry continues to claw its way back from the Great Recession, the federal government continues to add obstacles. On January 10, 2014, yet another regulation will become effective: The Qualified Mortgage.
The Qualified Mortgage (also referred to as “QM”), was designed to create safer loans by prohibiting or limiting certain high-risk products and features. Under the law, lenders who write Qualified Mortgages can sell these loans into the secondary market and are promised some degree of legal protection against borrower lawsuits.
On the surface, the concept of a Qualified Mortgage sounds lovely! After all, who would argue against safer mortgages and lower default risks? However, like most aspects of the Dodd-Frank financial reforms, the resulting consequences will do little to protect consumers. In fact, QM promises to harm many borrowers!
- Working-class families will likely find it more difficult to qualify for mortgage loans.
- Financially sophisticated borrowers will see many of the loan options they’ve enjoyed eliminated.
- And finally, lower income borrowers, the very borrowers whom are most likely to need protection, will see the availability of mortgage financing, as well as their ability to qualify, drastically reduced!
Let’s break down QM and look at the main aspects to be implemented:
Limits On Loan Features.
For a loan to be considered QM, it must be free of the following features:
- Interest Only Payments
- Negative Amortization
- Balloon Payments
- Loan Term Exceeding 30 Years
As with most aspects of life, one size does not fit all. While many borrowers favor the generic 30 Year Fixed mortgage, many sophisticated borrowers still prefer to utilize interest-only or neg-am loans as part of an integrated financial plan. Come January, many lenders will discontinue offering these options altogether.
Ability To Repay.
Under QM, lenders must consider at least these minimum factors when underwriting a loan:
- Current Employment Status
- Current or Reasonably Expected Income or Assets
- Monthly Payments on the Subject Transaction
- Monthly Payment(s) for Mortgage Obligations
- Current Debt Obligations, including Alimony or Child Support
- Debt-To-Income and Residual Income
- Credit History
Do these criteria sound familiar? They probably should, as most lenders have been applying these underwriting guidelines for decades. Therefore, this entire section of the law seems classic government overkill and repetitively unnecessary.
However, of grave concern is the requirement that limits a borrowers’ Debt-To-Income Ratio to 43% of their gross qualifying income. While it may be financially irresponsible for many borrowers to leverage themselves with larger than necessary mortgage payments, there are some segments of the population that will be harmed by this hard and fast rule. For example, low-income households tend to spend a larger percentage of their income on housing. In addition, affluent borrowers very often can budget over 50% of their gross qualifying income towards housing payments, with the balance of their income more than sufficient to maintain their lifestyle.
The QM rules temporarily allow mortgages that meet government or agency (Fannie or Freddie) eligibility to be considered “qualified.” However, this will be transitioned out once a replacement for Fannie and Freddie is created and this replacement agency writes its own QM rules.
Caps on Points and Fees.
The 3% test rule says 3% of the mortgage amount is the maximum amount of fees that can be charged to a borrower. Anything above this limit would disqualify the loan from QM.
On the surface, this sounds like a wonderful idea to protect borrowers from high-priced loans and predatory lenders. However, this presumption could not be further from the truth.
The reality is that the criteria of what is defined as a “fee” is complex, depending on who the fee is paid to, how it is paid, and even has differing definitions for lenders versus brokers. There are many other variables that factor into the equation, including Private Mortgage Insurance (PMI), and Annual Percentage Rate (APR), which in and of itself is a complex, often misunderstood, and subjective calculation depending on the lender.
Ultimately, borrowers comparing two loans, both absolutely identical in loan size, interest rate, and fees, will find one qualifying for QM whereas the other does not.
Lastly, borrowers living in high-cost areas of the United States (such as our tri-state area) and in need of a relatively small loan may find these loans harder to obtain, as banks may no longer find these loans profitable. Like any industry or business, if a product or service offered proves unprofitable, it is eventually eliminated.
“Safe Harbor” Protection for Lenders.
For banks lending Qualified Mortgages that still result on a borrower’s default or foreclosure, the lender would be considered having legally satisfied the Ability-to-Repay rule. Thus, its argued it would be harder for a borrower to sue the lender in court. However, borrowers can still challenge their lenders in court if they feel the loan falls short of the QM parameters. And herein lies the problem. These QM requirements are so numerous, complex, and open to interpretation, that corporate attorneys for many banks fear QM may open lenders to more litigation instead of less.
These new QM rules will have a significant impact on borrowers, lenders, and the real estate marketplace as a whole. Many lenders fear the income requirements of QM will price many borrowers out of the market. And despite claims to the contrary, according to risk management firm ComplianceEase, more than one in five mortgages written today would NOT pass the QM test!
Despite the gloom and doom, QM will not mark the demise of the mortgage industry or the American Homebuyer. In time, it’s predicted that an entire Non-QM market will develop, with unique and interesting loan programs to serve the needs of borrowers who desire more choices.
Warren Goldberg is President of Mortgage Wealth Advisors, a Certified Mortgage Planning Specialist®, and a published author. His interviews include Blog-Talk Radio, Newsday, and the Long Island Herald. Since 1992, he’s been sharing his financial knowledge and wealth-building strategies, including how to properly use your mortgage as a financial tool. His clients regularly express their trust and appreciation by recommending friends and family call when in need of mortgage, real estate, and financial guidance.