Most people are not aware that beginning January 10, 2014, the mortgage rules that banks and mortgage lenders have been following for many years changed. The changes resulted from new legislation passed by Congress after the financial crisis. You have probably heard of the Dodd-Frank Act, but you have probably not yet felt its impact. That may now change.
The Ability to Repay Rule
New rules were passed in an attempt to avoid lax mortgage lending by some "bad actors" that played a part in the financial crisis. However, as with much new legislation, this legislation may have unintended consequences. The most minor of the consequences is that borrowers are now required to provide significantly more documentation when they encounter the mortgage application process. This is because mortgage lenders now have to provide a "high degree" of evidence that borrowers have the financial ability to repay the loan.
Debt-To-Income Ratio Cap
The ability to repay
rule includes a new 43% cap on the debt-to-income (DTI) ratio of a borrower. This ratio is a measure of the total monthly debt payments of a borrower divided by their total monthly gross income. The monthly debt payments include such things as minimum monthly credit card payments, student loan payments, alimony, child support, car payments, housing association dues and any other monthly fixed debt obligations a borrower may have. It also includes an estimate of the monthly mortgage payment including insurance and tax escrow payments on the proposed mortgage.
Mortgage lenders generally look at a maximum DTI ratio of 36% as a guideline, but they have the flexibility to go above this figure based on other resources the borrower might have available to them. Much of this flexibility is being removed by the new rules.
Salary or "W-2" Income
For people who have what I would term as "W-2" income, meaning they work for a company and receive a monthly paycheck, documentation of income should not be a problem and they should be able to move through the process uneventfully. However, there are some people who a lender would normally consider to be creditworthy that will have a hard time qualifying for a mortgage under the new rules.
Retired People and Those on Fixed Incomes
Many people, who have retired, may have significant amounts built up in retirement assets but not significant income because they no longer work. They may experience challenges qualifying for a mortgage loan under the new rules. If their DTI ratio exceeds 43%, they will not fall under the "Qualified Mortgage
" designation of the new rules. At this time it is not clear whether a market will exist for loans classified as "Non-Qualified Mortgages." My hope is that as these challenges begin to manifest, legislation will be introduced to correct these issues. Otherwise, a market will probably develop over time, but it will likely be more costly to the borrower than a qualified mortgage.
How Can You Best Prepare for the Application Process?
When you meet with your mortgage loan officer, bring as much documentation as you can to substantiate the income sources you will use to apply for your loan. If you have W-2 income, bring at least two months of paystubs. If you have rental income, bring a copy of a signed lease agreement and two months of cancelled checks. The mortgage lender will need documentary evidence for any income sources they use to qualify you for your loan.
Most importantly, bring your patience. This will be a learning experience for borrowers and lenders for the first few months!