Here's a look at what they do and why they matter to potential home buyers.
New mortgage-lending rules take hold Friday that federal regulators say will guard against the risky lending practices that fed the housing bubble, which led to the greatest collapse in U.S. home prices since the Great Depression. For most home loan borrowers, the change will have little or no impact on whether they can actually get a mortgage, experts say, but they may have to show even more proof that they can afford one. Here's a look at the rules, what they do and why they matter.
Q: What are the new rules, and where did they come from?
A: There are several terms to know. The first is the "ability-to-repay" rule. It was required by the 2010 Dodd-Frank financial overhaul legislation as a response to the financial crisis. The rule was crafted by the Consumer Financial Protection Bureau, which will oversee its enforcement.
Q: What does it do?
A: It requires mortgage lenders to make sure borrowers can actually afford their loans, over the long term, by weighing their income, assets, savings and debt against their monthly house payments. "It really is pretty basic," says Richard Cordray, head of the CFPB. He calls the changes a "back to basics" approach for mortgage lending.
Q: What else is new?
A: Another term you need to learn is "Qualified Mortgage" or QM. A QM meets new guidelines, and borrowers who get them are presumed to meet the ability-to-repay requirements. If lenders make QM loans, they have more protections against future lawsuits should the loans later go sour.
Q: What are the QM guidelines?
A: QM loans cannot:
• Contain risky features, such as terms that exceed 30 years, interest-only payments or payments that are less than the full amount of interest so that the home loan debt grows each month.
• Carry more than 3% in upfront points and fees for loans above $100,000.
• Push a borrower's total debt load above 43% of his or her monthly income, unless the loan is eligible to be backed by Fannie Mae or Freddie Mac, or a federal housing agency such as the FHA, or is made by a small lender that keeps the loan on its books.
Q: Can lenders still make loans outside those guidelines?
A: Yes, but they'll still have to make sure borrowers can afford the loans, and they'll have less protection against future legal challenges if the borrower fails — even if they resell the loan after they first make it.
Bank of the West, for instance, says it'll continue to do interest-only loans. Many borrowers in high housing-cost areas also frequently have debt-to-income ratios that exceed 43% and lenders will likely keep making home loans in those areas, too.
"We're seeing a lot of lenders say they'll keep making" non-QM loans that are "perfectly sound," Cordray says.
Q: How many mortgages are likely to fall under the QM definition?
A:The CFPB estimates that 92% of mortgages in the current marketplace meet the QM requirements.
Q: Why is this needed at all?
A: Lenders weren't always so careful. Goldman Sachs estimates that 50% of recent home loan defaults could have been prevented had the QM rule been in place when the loans were made, largely before the housing bust.
Over time, should the housing market get superheated again, the new rules will "serve as a barrier," against risky loan practices, says Ira Rheingold, executive director of the National Association of Consumer Advocates.
Q: Will the rules make it harder for some people to get home loans?
A: That's not clear. Goldman Sachs says it may be tougher for borrowers to qualify if they have difficult-to-validate incomes, including those for whom tips, bonuses, commissions, rents or investments constitute a big part of their total income. One in nine Americans are also self-employed, and that income is harder to substantiate than is wage income, Goldman says.
Borrowers above the 43% debt-to-income level will also face more hurdles, but mostly in terms of documentation, says Wendy Cutrufelli, Bank of the West vice president.
That's because lenders have to be able to prove that they exercised extreme due diligence in making such loans, she says. Borrowers should expect to have to produce even more tax records, pay stubs and bank and investment account information.
The 43% standard may also prevent some borrowers from qualifying for the loan needed to buy the house they want, says Roelof Slump, managing director of Fitch Ratings. Others may need bigger down payments to stay within the 43% standard, he says.
Q: What's going to be the required minimum down payment?
A: The rules don't set any down-payment requirements.
Q: Will the rules mean it'll take longer to get home loans approved?
A: They may, especially early on, says Keith Gumbinger, mortgage expert with HSH Associates. It'll still take lenders more time to get systems up and running that track and handle new documentation requirements. While lenders have had months to prepare, he still expects that loan officers, underwriters and compliance offers will need more training.
"It'll be a muddy mess until the rules settle in," he says.
Q: What are the downsides to these changes?
A: Critics say minimum-down-payment requirements would be a good thing. Goldman Sachs' analysis also shows that eliminating loans with risky features would have prevented 59% of defaults that occurred in loans issued in 2007; it also would have prevented 30% of the loans that didn't default, too.
