Some new mortgage-lending rules are scheduled to take effect next year, and they could steer even more borrowers into the already popular FHA loan program. It all depends on how those rules are defined.
On July 21, 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act was signed into law. This legislation seeks to curb many of the risky financial practices that contributed to the U.S. recession of the late 2000s.
Coming in 2013: The Qualified Mortgage
On the mortgage-lending front, it calls for the creation of a qualified mortgage (QM), a set of rules intended to produce safer home loans. It also calls for a separate, but similarly named, requirement known as the qualified residential mortgage (QRM). Both rules are scheduled to take effect in January 2013, or shortly thereafter.
As shown below, the borrower’s ability to repay is a central theme of the QM guidelines.
To learn more about the forthcoming QM rules, please refer to our qualified mortgage fact sheet.
How Will QM Affect Lending Standards in the U.S.?
A 2011 study conducted by the U.S. Government Accounting Office (GAO) found that the QM-related provisions of the Dodd-Frank Act may have minimal impact on the mortgage market. They examined some of the QM criteria outlined in the Dodd-Frank Act, and compared them to mortgage loans generated between 2001 and 2010. Their determination: “Most mortgages would likely have met the individual criteria.”
In other words, the forthcoming rules might not change much.
QM is designed to prevent a return to the days of exotic, high-risk mortgage loans. But most of the ‘creative financing’ options used during the housing boom have already fallen by the wayside. Lenders have gotten away from using them. Stated-income loans and interest-only mortgage payments are two good examples. These features were all the rage during the housing boom. But when the bubble burst, lenders began to avoid them. These are the types of high-risk features Dodd-Frank seeks to eliminate, by implementing the qualified mortgage standards.
On the other hand, the GAO study does point out that QM could limit mortgage options for some borrowers. Here is a quote from their report to Congress:
“…some consumer and industry groups stated that some of the QM criteria could increase the cost and restrict the availability of mortgages for some borrower groups, including lower-income and minority borrowers.”
Much depends on the final version of these rules. The Consumer Financial Protection Bureau (CFPB) has evaluated feedback from the consumer and industry groups mentioned above. They are now on track to finalize the qualified mortgage rules by January 2013, barring any procedural delays. It should be an interesting year, as far as home loans go.
More Borrowers Lining Up for FHA Loans?
An FHA loan is a residential mortgage loan that is insured by the U.S. government, under the management of the Department of Housing and Urban Development (HUD). This type of financing is popular among first-time home buyers, in particular, because it allows for a down payment of only 3.5%. But it’s not limited to first-time buyers. Anyone who meets the program guidelines can qualify for this type of financing.
FHA loans also have less strict qualification criteria, when compared to regular conventional mortgages. This appeals to borrowers with low credit scores or other qualification problems.
The popularity of the FHA program spiked in the wake of the housing crisis. As lenders tightened their standards to prevent further losses, many marginally qualified borrowers had nowhere else to turn. As a result, the FHA’s market share rose from around 5% to nearly 40% in just a few years (see chart below).
Today, it is still one of the most popular financing options for first-time home buyers, and those with credit problems. The low down-payment requirement, combined with less rigid criteria, makes FHA the first choice for many borrowers.
Will even more borrowers flock to the program in 2013, as the QM rules take effect? It’s a likely scenario. But again, it all hangs on the final definition of the qualified mortgage.
For instance, we know by reading through the Dodd-Frank Act that debt-t0-income (DTI) ratios will come into the picture. But we don’t yet know the limits for these ratios. Dodd-Frank simply states that a QM loan must comply with “any guidelines or regulations established by the Board relating to ratios of total monthly debt to monthly income … taking into account the income levels of the borrower.”
If they impose stricter guidelines for DTI ratios than we’ve seen in 2012, they could inadvertently drive more borrowers toward FHA loans in 2013. It’s worth watching, at the very least.
Mortgage Rates Hovering at Record Lows
In other lending news, mortgage rates in the 30-year and 15-year categories inched upward a bit yesterday. But they are still hovering at record lows. On November 29, 2012, Freddie Mac reported that the average rate for a 30-year fixed mortgage rose from 3.31% to 3.32%. That makes this week’s average the second lowest in four decades of tracking.
Rates are expected to remain low for the rest of this year and into 2013, minor fluctuations aside. This, combined with the prospect of stable and rising home prices, may bring more buyers into the market in 2013.
According to Frank Nothaft, chief economist and vice president at Freddie Mac: “even if we see some upward pressure on fixed-rate mortgages in 2013, they are still likely to remain extraordinarily low.”