After three years of debate and acrimony, the new mortgage standards which were supposed to be part of Wall Street reform are finally coming into place. The result is that mortgage shopping is about to be a new — and duller — experience.
Under Wall Street reform lenders have every incentive to offer what are called “qualified mortgages,” or QMs. They can make non-QMs, but once they step outside the QM boundaries a whole set of unfriendly rules come into play, including huge potential liabilities to borrowers.
A “qualified mortgage” is — basically — an FHA, VA, conventional or portfolio loan. It must have a fully-documented loan application, points and fees cannot exceed 3 percent of the loan amount and the debt-to-income ratio cannot be greater than 43 percent of the borrower’s monthly earnings. There are other standards as well, but generally we’re going back to the 1990s in terms of common loan options.
The mortgage marketplace is being remade to reduce investor and borrower risk. If there’s less risk then investors will be more likely to purchase U.S. mortgages and when there is more investor participation then rates tend to be lower.
One by-product of Wall Street reform is that a number of loan concepts which lead to the mortgage meltdown are going into the dustbin of financial history. Few lenders will be willing to make option ARMs, interest-only loans and no-doc loan applications under the new rules. As well, here are several examples of the changes we’ll be seeing with the advent of qualified mortgages.
First, loans that are not self-amortizing will become rare. In other words, balloon notes — loans with a short term and then a huge single payment — are out.
Balloon notes are often used by investors looking for short-term financing. However, under the old standards they could be sold to homeowners who did not fully understand their terms and conditions. Now, because of the qualified mortgage guidelines, the availability of balloon notes will be greatly restricted.
Second, loan terms will be limited to 30 years. The attraction of 40-year mortgages is that they offer smaller monthly payments. For example, a $150,000 mortgage at 4 percent interest has a monthly payment for principal and interest of $716 over 30 years. The same loan stretched to 40 years has a monthly payment of $627.
The catch is that the 40-year mortgages have a slower amortization rate because the term is so much longer than a 30-year note. Total potential interest for the 30-year loan in this example is $108,000 versus $151,000 for the 40-year term. If the property is sold after10 years the balance for the 30-year loan will be $118,000. What’s the balance after 10 years for the 40-year loan? That’s $131,000.
Like balloon notes, 40-year mortgages have their advocates. After all, lower monthly costs mean more people can qualify for financing but for the moment, at least, such financing is outside the realm of qualified mortgages.
Third, total points and fees in excess of 3 percent are not allowed for most qualified mortgages.
But what counts against the 3 percent limit? In Washington the answer to this question and others like it is worth billions of dollars, reason enough for special-interest lobbyists and lawyers to argue the issue with great ferocity.
Already this debate has had an impact: The Consumer Financial Protection Bureau has amended several definitions under the new mortgage rules, other guidelines have been deferred until January 2014 and the House has held a hearing regarding the question of “how the Dodd-Frank Act hampers home ownership?”
Will there be more changes to the rules? Maybe yes, maybe no, but one thing is certain: The debate will go on.