A Quick Overview of the New Mortgage Rules

The new mortgage rules require lenders to tighten their underwriting norms. They are designed with the objective of reducing the risks of loan defaults and foreclosures. The new rules apparently promise 'no surprises, no debt traps and no runarounds'.

Lenders now have to comply with 2 new requirements: The Qualified Mortgages and Ability to Repay. Here is how these two new requirements will affect the borrower.

Ability to Repay

Lending institutions are required to verify that the borrower has the assets and income required to afford the monthly payments throughout the entire life of the mortgage. In order to determine this, the lender may assess the borrower's debt-to-income ratio.

To calculate the debt-to-income ratio, you just need to add up your monthly expenses and divide that figure by your monthly income.

Low-Doc loans

Earlier lenders used to offer low-doc or no-doc loans without verifying the financial credentials of the borrower. However, the new mortgage rules require the lender to verify and document the borrower's income, debt, assets and credit history. This will involve more paperwork. It may also prolong the processing times. However, the new rules will ultimately benefit both the borrower and the lender.

Underwriters are also required to approve mortgages on the basis of the maximum monthly payments the borrower will have to make. They are not supposed to approve loans based on the lower teaser interest rates which last only a couple of months or years.

Qualified Mortgages

This rule ensures that the borrower will not buy a bigger home than s/he can afford. The new mortgage rules insist that a borrower's debt-to-income ratio should be less than 43%. There are exceptions to this rule and banks can issue mortgages to people with higher debt-to-income ratio if they are convinced that the borrower has assets that justify the higher loan amount.

The term of a qualified mortgage cannot be longer than thirty years. They also cannot have risky features like interest-only payments and minimum payments that do not cover the whole of the interest cost. If your monthly payments fall short of your interest cost, your mortgage balance will grow. This is called negative amortization.

In addition, the upfront fees that banks charge cannot be more than 3 percentage of the loan balance. That includes origination fees, title insurance and any points paid to reduce mortgage interest rates.

There are also rules that discourage lenders from offering financial incentives to mortgage brokers and loan officers for pushing borrowers into higher-interest mortgages they can't afford. The new rules will offer borrower protection without limiting their access to credit.

Lenders also seem to be happy about the new mortgage rules. The only concern they have is that the new rules might slow loan processing.

Interestingly, the new mortgage rules do not specify a minimum credit score or down payment requirement.

The fact that there is no minimum down payment requirement will benefit most first time homebuyers who might find it difficult to raise that much money. The lack of credit score requirements might enable banks to loosen their underwriting practices sometime in the future. That said, loans still need to be supported by Freddie Mac and Fannie Mae. Since these organizations are unlikely to approve applicants with credit scores below 620, most borrowers need to have a credit score of at least 620 to qualify for a mortgage.

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