Summary: The long-awaited, and somewhat anticlimactic, qualified residential mortgage (QRM) rule was released to the public last week in proposal form. The credit score and credit-history requirements that were written into the original proposal have since been removed. It seems the government has no interest in imposing credit standards on conventional home loans. Debt-to-income ratios, however, are still included in the QRM rule.
The federal government wants to make safer, low-risk mortgages “standard issue” across the lending industry. So they are forging some new rules to achieve that goal.
The qualified mortgage (QM) rule was published earlier this year by the Consumer Financial Protection Bureau (CFPB). The similar-sounding qualified residential mortgage, or QRM, is currently being finalized.
The 505-page proposal published last week was anticlimactic in the sense that QRM will not have a definition of its own. Instead, it will be aligned with the QM definition. According to the six federal agencies crafting the new mortgage rule, this is being done to increase compliance and reduce borrowing costs to consumers.
Credit Reports, Scores Left Out of QRM Proposal
It also seems that consumer credit scores and credit histories will be left out of the final QRM definition, just as they were left out of the previous QM rule. This would allow mortgage lenders to continue making their own decisions regarding credit profiles, without having to use a government-imposed standard.
Credit report analysis was included in previous QRM proposals. The agencies originally planned to implement certain rules and standards relating to the borrower’s credit history. They also wanted to require a 20% down payment across the board. Both of these measures would have put mortgage loans out of reach for many people who are currently able to obtain financing. First-time home buyers, in particular, would have been heavily affected by the down-payment requirement.
The latest proposal states the following: “In the original proposal, the criteria for a QRM included an LTV ratio of 80 percent or less for purchase mortgages and measures of solid credit history that evidence low credit risk.”
As previously proposed, the QRM rule would have required lenders to evaluate the borrower’s credit reports and scores. It also would have blocked lending to borrowers with 30-day late payments on their credit reports. But this and other aspects of the credit-history requirement met fierce resistance from those who commented on the rules.
According to the latest proposal, which includes a summary of past discussions and debates: “Commenters were also critical of the proposed credit history requirements (in particular, the 30-day past due restriction)…”
It’s not that credit reports and scores aren’t useful to mortgage lenders. They are. Lenders routinely use them as a risk-assessment tool when considering borrowers for home loans. The concern is that a government-imposed standard could squeeze out borrowers who were otherwise well-qualified for a mortgage.
To quote the latest proposal: “these additional credit overlays may have ramifications for the availability of credit that many commenters argued were not outweighed by the corresponding reductions in likelihood of default from including these determinants in the QRM definition.”
In other words, a credit-history requirement might have done more harm than good.
Based on these considerations, the agencies currently do not plan to implement credit-history standards as part of the final definition of QRM.
To learn more about the qualified residential mortgage rule, as outlined in the current proposal, please visit our QRM resource website.
Debt-to-Income Ratio Now Takes Center Stage
With credit report histories being removed from the QRM proposal, debt-to-income ratios are now taking center stage.
Most of the QM and QRM requirements relate to the mortgage loans themselves. For instance, the rules prohibit certain types of risky loan features, such as negative amortization and interest-only loan payments. But there is also a key requirement that relates to borrowers. It’s the debt-to-income ratio, or DTI — a comparison between the amount of money a person earns, and the amount he or she pays on recurring debts.
The QM rule, which protects lenders from certain lawsuits if they make “safe” mortgage loans, requires borrowers to have a total DTI ratio less than or equal to 43%. There are exceptions to this rule for smaller lenders, including community banks and credit unions. But for the most part, 43% DTI will become the new standard for home loans. And since the QRM rule is being cross-referenced with the QM rule, it too will impose a 43% debt-to-income limitation.
What This Means for Borrowers
Credit reports and scores have long been an important part of the mortgage lending process, and they will remain so. The federal government may not impose credit-history standards as part of their forthcoming QRM rule, as previously proposed. But even so, mortgage lenders will continue to use credit reports and scores when evaluating potential borrowers. A higher score increases your chances of getting approved for a home loan, while a lower score has the opposite effect.
The QRM rule is being finalized by six federal agencies, including the FDIC, SEC and HUD. They’ve evaluated “historical loan performance data” to determine which mortgage features and criteria could reduce the risk of default. Among other things, their research revealed that few loans are being given to borrowers with credit scores below 620 (full story).
Another clear trend is emerging with regard to debt-to-income ratios. Financial regulators appear to be drawing a line at 43% total DTI, as far as what’s considered a “quality” mortgage loan. This means that borrowers with DTI ratios above 43% may find it harder to qualify for a loan, once the new rules take effect.
The QM rule goes into effect in January 2014. We do not yet know the final implementation date for QRM. The cutoff for the comment period on the current QRM proposal is October 30, 2013. So it too will likely be implemented sometime in 2014.
Some Useful Graphics
A picture is worth a thousand words. To that end, we have created a couple of infographics designed to help consumers understand these forthcoming rules. These graphics are part of our not-for-profit educational website, QualifiedResidentialMortgage.org, which serves as a repository for news, documents and information relating to the QRM rule. You may use these graphics if you link them to the source website.