Editor’s note: New mortgage rules scheduled to take effect in 2014 could fundamentally change the way home loans are created. All borrowers should know about these forthcoming changes. To help you sort it all out, we have created this handy guide to the 2014 mortgage lending rules.
3 New Mortgage Rules and Laws for 2014
The Qualified Mortgage rule is coming in 2014. For that matter, so are the Ability-to-Repay rule, the Qualified Residential Mortgage rule, and a series of other changes that could permanently alter the lending industry.
Confused? You have a right to be. Two of the new rules have very similar names and definitions, but different applications. On top of that, there is a cloud of misinformation floating around the Internet. It’s enough to make one’s head spin.
This guide will help you make sense of the new mortgage rules and other lending changes coming in January 2014. Here are three rules, and a handful of other changes, you need to know about:
1. Qualified Mortgage (QM)
The Qualified Mortgage (QM) rule was required by the Dodd-Frank Wall Street Reform and Consumer Protection Act. It was finalized by the Consumer Financial Protection Bureau (CFPB) in January 2013, and will take effect on January 10, 2014. The purpose of the QM rule is to reduce risk within the lending industry. QM is designed to prevent the types of high-risk loan features that were commonly used during the housing boom.
This will be one of the most influential new lending laws of 2014, because many of the other rules and requirements are being aligned to match it. What borrowers need to know is that QM will soon set the bar for the mortgage industry. The changes introduced by this new rule will have far-reaching effects. Here’s a graphic that explains the key points of this forthcoming regulation, courtesy of QualifiedMortgage.org:
As you can see, this new mortgage rule will introduce some sweeping changes for the lending industry. It will limit most of the lender’s points and fees to 3% of the loan amount. It will prohibit some of the riskier loan features, such as balloon payments and negative amortization (where the principal balance can actually grow over time).
Other changes include a 43% debt-to-income ratio limit, which could squeeze some borrowers out of the mortgage market. Lenders must also ensure borrowers have the financial means to repay their debts, which is further explained below.
Banks and lenders have a strong incentive for adhering to this particular mortgage rule. When they create “QM-compliant” loans, they will receive a certain degree of legal protection from consumer lawsuits. There are two types of protection, based on the pricing of the loan.
- Lower-priced mortgage loans (those with an interest rate at or near the Average Prime Offer Rate, or APOR) will have a fairly broad “safe harbor” type of legal protection.
- Higher-priced loans (those with an APR that is “1.5 percentage points or more over the Average Prime Offer Rate”) will receive a more narrow “rebuttable presumption” form of protection.
As a result of these legal protections, we can probably expect most lenders to generate QM loans most of the time. So the new mortgage rules for 2014 will essentially become the new normal for the lending industry.
What it means for borrowers: The QM rule is designed to protect consumers from risky loans. That’s a good thing. But the new law will also establish some hard limits for debt-to-income ratios. Borrowers with too much debt may have trouble qualifying for a mortgage in 2014, when the new lending rules take effect.
2. Ability to Repay (ATR)
This new mortgage requirement was originally proposed as part of the QM “umbrella” regulation mentioned above. But the CFPB announced it as a separate rule in January 2013, so we will do the same. Just know that the Ability-to-Repay (ATR) and the Qualified Mortgage (QM) requirements go hand-in-hand. In fact, they are often referred to collectively as the ATR/QM rule. Where one goes, so does the other.
ATR doesn’t make any sweeping changes to the lending industry. Instead, it merely enforces something that lenders should be doing anyway — asset and income verification.
QualifiedMortgage.org offers a concise definition: “The Ability-to-Repay rule protects consumers from taking on mortgages that exceed their financial means, by mandating the documentation / proof of income and assets.”
According to the CFPB, which finalized this new rule for 2014, lenders must “make a reasonable, good-faith determination before or when [they] consummate a covered mortgage loan that the consumer has a reasonable ability to repay the loan.”
To make this determination, lenders must look at eight specific underwriting factors. These include the borrower’s current income, employment status, estimated monthly mortgage payment, property taxes, debt-to-income ratio and more. (You can view all eight requirements here.)
You might be wondering why the lending industry would even need a rule like this. After all, it only makes sense for lenders to verify a borrower’s payment capacity. The problem is that common-sense income verification fell by the wayside during the housing boom. In the drive to qualify more borrowers, many lenders moved away from these sensible practices. That story ended badly, to say the least. So federal regulators have created new mortgage rules to prevent a return to lax underwriting. The ATR requirement is one of those rules. It takes effect on January 10, 2014, along with QM.
What it means for borrowers: So what does the ATR requirement mean for those seeking a home loan? Documents, and plenty of them. The underwriter will need to see a variety of documents to verify your ability to repay the debt, as required by the ATR rule. These include bank statements, pay stubs, tax returns, W-2s, and possibly some letters of explanation (LOEs) for any red-flag issues.
3. Qualified Residential Mortgage (QRM)
This is where things get confusing, so hang in there. The Qualified Residential Mortgage (QRM) sounds a lot like the QM rule mentioned above. It’s actually built around the same set of requirements. It prohibits negative-amortization loans, caps points and fees at 3%, and limits borrowers to a debt-to-income ratio of 43% or lower. So in a sense, it’s the same rule.
The difference lies in how the QM and QRM regulations are applied, and what they mean for mortgage lenders:
- The QM rule is designed to reduce risk in the lending industry, by creating a safer class of mortgage loans. In exchange for generating loans that meet the QM rules, lenders will be given a certain degree of legal protection from consumer lawsuits. It will bring several changes for the mortgage industry in 2014. (See previous discussion above.)
- The QRM rule is still being finalized by the FDIC and five other federal agencies, as of November 2013. The latest development is that it will aligned with the QM definition. This regulation mostly applies to lenders, and to the investors who purchase the loans sold by lenders. In short, QRM loans are exempt from the 5% risk-retention requirement created by the Dodd-Frank Act. If a loan meets the definition of a Qualified Residential Mortgage, the lender can sell it into the secondary market without retention limits.
We have created a simple infographic to help you understand these new, and closely related, mortgage rules that take effect in 2014.
What it means for borrowers: Not much, really. The loan requirements under QRM are the same as those mentioned earlier, for the QM rule. This new law changes things for lenders, by giving them a way to circumvent risk-retention rules. But it probably won’t have a direct or major impact on borrowers.
What These Changes Mean for Borrowers
Time for the million-dollar question. How will these new mortgage rules change the lending industry? Will they make it harder to get a home loan? Here’s our take on this:
Some borrowers who may qualify for a mortgage loan in 2013 could have a harder time of it in 2014. I’m primarily referring to those who carry a lot of household debt in relation to their monthly income. Debt ratios are central to the QM rule coming in 2014. Generally speaking, lenders that want to create QM-compliant home loans must ensure that “the borrower’s total debt-to-income ratio is not higher than 43 percent” (source: CFPB fact sheet).
Lenders can still generate loans that fall outside of the QM rules. But they won’t enjoy the added layer of legal protection (either the safe harbor or rebuttable presumption, depending on the loan pricing). These legal shields are a powerful incentive for an industry that is ever fearful of lawsuits. So it’s reasonable to expect that most lenders will stay within these boundaries for most of the loans they make. Thus, we can expect the 43% rule to have a broad impact on borrowers.
Consumers with minimal debt have little to fear from these 2014 mortgage changes. On the other hand, prospective borrowers who are pushing the 43% debt-to-income limit should look at ways to reduce their other debts, such as credit cards.
Borrowers may also have to jump through additional hoops, where documents are concerned. Most lenders have already tightened up their documentation requirements since the housing and mortgage crisis. That’s why it’s nearly impossible to get a “stated-income” home loan these days. The new lending rules will be the final nail in the coffin for lax income-verification. The Ability-to-Repay rule, in particular, requires lenders to obtain and verify a wide range of documents to ensure borrowers have the means to repay their loans.
There is also the cost factor to consider. Banks and mortgage lenders will face additional operating costs in 2014, as a result of the new rules. It costs money to hire compliance staff, reconfigure software programs, and the like. Some lenders might pass these costs along to the borrower, in the form of higher rates and/or fees. At present, there is no way to measure the likely impact or cost of such changes. But it will almost certainly be a factor, to some degree.
As you can see, there are many new rules and changes that will affect mortgage loans in 2014. It will be an interesting year, as far as the lending industry is concerned. If you would like to learn more about these new lending laws and regulations, we encourage you to visit the two resource websites we have created — QualifiedMortgage.org and QualifiedResidentialMortgage.org.