From the earliest days of mortgage loan approval standards, first and foremost, it had to be the math.
Did the totals of your house payment and monthly recurring bills divided by your total monthly income stay at or under a specific debt-to-income ratio, or DTI?
If your numbers checked out, you were one step closer to loan approval and homeownership. If not, no home for you.
In response to the 2007-10 mortgage crisis when disingenuous standards ruled the roost, the Consumer Financial Protection Bureau (effectively the mortgage police) moved to a universal, regulated underwriting standard, named Qualified Mortgage, or QM.
It required lenders to make reasonable, good faith determinations, based upon verified documentation that the borrower had the ability to repay that mortgage.
The big new line in the sand for lenders was a 43% maximum debt-to-income ratio for all but Fannie, Freddie, FHA and VA loans.
Lenders failing to comply could be held liable to consumers for damages including complete loan rescission. The CFPB didn’t want a repeat of lenders dishing out loans to unqualified borrowers. Lenders paid a steep price if they did.
But on Dec. 10, the CFPB issued a new General QM Final Rule removing the 43% cap.
Under the new rule, creditors must consider the consumer’s DTI ratio, residual income or assets other than the value of the dwelling and debts. Creditors can mix and match underwriting rules from Fannie, Freddie, FHA or VA.
In fact, lenders can do just about anything so long as they document what they do, have written policies and are prepared to defend their ability-to-repay thinking. Fannie and Freddie loans are still exempt.
Most importantly, the bureau’s new litmus test goes to price. A mortgage qualifies for QM safe harbor if it is a first lien with an annual percentage rate that does not exceed the average prime offering rate, or APOR, by more than 150 basis points. The APOR is a weekly survey-based estimate of average APR’s.
For example, as Dec. 7, the APOR for a 30-year fixed was 2.76%. If the APR of your loan does not exceed 4.26% (2.76% plus 150 basis points), your loan would be considered a QM safe harbor loan.
A second category allows the APR to be 225 basis points over the APOR, but with a rebuttable safe harbor presumption.
We also now have a Seasoned QM Final Rule. This largely follows the same ability-to-repay rule, but it is designed for riskier, higher-priced mortgages (what we currently call non-qualified or exotic mortgages) that don’t meet the General QM APR caps.
To achieve safe harbor status, the Seasoned QM loan may not have more than two 30-day mortgage late payments in the first 36 months.
This new rule emphasizes a more holistic approach to mortgage credit, especially for underserved and lower-income borrowers. For example, small community banks that know their customers and their habits can make prudent decisions without getting stopped by excessive ratios.
Roger Fendelman, partner at the Garris Horn LLP law firm, noted the old rule hampered recent immigrants without established credit from getting a mortgage.
“If you want to take a chance on people, you will be able to,” he said.
These new rules are good for consumers and lenders.
“Protection for consumers stays in place,” said Guy Cecala, CEO and publisher of Inside Mortgage Finance. “The CFPB didn’t realize (its original 43% DTI rule) had such a chilling effect on non-QM loans.”
Since the original rule, only about 2% of all mortgages were non-QM, according to Cecala.
What does this mean for jumbo loan borrowers, or those borrowing over $822,375 in L.A. and Orange counties and over $548,250 in the Inland Empire?
“It’s good,” said Dave Stevens, retired CEO of the Mortgage Bankers Association. “It was ridiculous for wealthier borrowers with higher incomes (to be capped at 43%).”
What about risk?
Surprising to me, criticism of these new rules came from a 40-year industry veteran who works in the exotic mortgage space.
“There is always higher natural risk when you go to higher DTI’s,” said Joe Lydon co-founder and managing director at San Diego-based LendSure, a non-QM mortgage lender. “COVID-driven higher home prices hide the blemishes. Go back to 2005. As soon as business started going to higher DTI’s, delinquencies increased.”
(Full disclosure: My firm, Mortgage Grader, is a LendSure customer.)
Lenders may start using the General QM Final rule now. The Seasoned QM Final Rule and the General QM Final Rule will take effect 60 days after publication in the Federal Register.
Jeff Lazerson - Mortgage Columnist since 2011