What will the basic criteria for a mortgage loan be in 2014? You don’t need a time machine to find out. The Consumer Financial Protection Bureau recently published a guide for mortgage lenders that outlines the criteria for the Qualified Mortgage (QM) and Ability-to-Repay (ATR) rules. These two rules, which take effect in January 2014, will essentially set the bar for mortgage lending criteria in the U.S.
Ability-to-Repay Criteria (ATR) at a Glance
The Ability-to-Repay rule requires mortgage lenders to verify the borrower’s ability to repay the loan (hence the name). It also establishes some specific underwriting criteria for mortgage lenders. I wrote about those criteria in a previous story. Here’s a recap.
Under the ATR provision, lenders must consider the following mortgage criteria at a minimum:
- Current income and assets
- Current employment status (if employment income will be used to qualify for the mortgage)
- Expected monthly payments for the mortgage loan
- Monthly payments for other loans associated with the property (i.e., second mortgages)
- Estimated payment amount for property taxes, homeowners insurance, and HOA fees
- Total amount of the borrower’s recurring monthly debts
- Borrower’s debt-to-income ratio, or DTI
- Borrower’s credit history
These eight points give us some insight into the standard criteria for mortgage lending in 2014. For the most part, this is what lenders are doing right now.
During the housing boom, you could circumvent many of these requirements by using one of several “exotic” mortgage products, such as the stated-income or no-documentation (“no doc”) loan. But lenders have stiffened their mortgage criteria since then. The bottom line is that most lenders already adhere to these eight underwriting checkpoints, even though the ATR rule doesn’t take effect until 2014.
The takeaway: Lenders will carefully consider your ability to repay the loan, using the eight mortgage criteria listed above (at a minimum). Lenders can impose their own guidelines on top of the minimum criteria established by these new rules.
Mortgage Criteria Required Under QM
The Qualified Mortgage, or QM, is another significant rule that will take effect in January 2014. While the ATR mortgage criteria focus primarily on the borrower’s ability to repay, the QM rule is geared toward the prohibition of risky loan features. QM also puts a cap on certain mortgage fees and imposes a minimum debt-to-income ratio for borrowers.
Here are some highlights from the CFPB lender guide mentioned earlier:
- Under the QM criteria for mortgage loans, certain “risky features and practices” are prohibited. These prohibited features include negative-amortization home loans (where the outstanding balance increases) and loans with interest-only payments.
- In general, borrowers will be limited to a total debt-to-income ratio, or DTI, no greater than 43%. Of all the mortgage criteria included in the new rules, we expect this one to have the biggest impact on borrowers. Many people will be excluded from the market as a result of having too much debt.
- Points and fees charged by the lender cannot exceed 3% of the amount being borrowed. This rule generally applies to mortgages of $100,000 or more. Points and fees can exceed 3% on smaller loans below $100,000.
Lenders who adhere to these basic criteria for mortgages will be given some form of legal protection against consumer lawsuits. “Higher-priced” mortgage loans — defined as loans with an APR that exceeds the average prime offer rate (APOR) by 1.5% or more — will have a rebuttable presumption that offers limited legal protection. Mortgage loans that are not higher-priced will have a safe harbor that provides even more protection for the lender. So the banks have a strong incentive for following these criteria for mortgage loans.
Credit Scores Not Included in New Rules, but Still Important
Credit score criteria have not been written into the ATR and QM rules. But they’re still important for borrowers. Mortgage lenders use these three-digit numbers as a risk-analysis tool. A borrower with a low credit score is considered a higher risk by the lender, and will therefore have a harder time getting approved for a loan.
Minimum mortgage criteria for credit scores vary from one lender to the next. Based on a number of surveys and conversations with lenders, we have determined that most are setting the bar somewhere between 620 and 640, on the FIFO scale. Borrowers with scores below 620 may have a harder time qualifying for a mortgage.
Disclaimer: This article examines some of the criteria for mortgage loans we may encounter in 2014. This information was adapted from rules and guidelines available at the time of publication. Lending guidelines change all the time. So there is a chance this information may become less accurate over time. The best way to find out if you are qualified for a mortgage is to apply for one. Don’t let something you read online discourage you from taking this important step.