New Mortgage Rules Have Moved In
Many home buyers will now face greater scrutiny as they apply for mortgage loans. That’s because new regulations that went into effect in January require lenders to analyze potential borrowers’ ability to repay the mortgages for which they’re applying.
The rules come from the Consumer Financial Protection Bureau (CFPB) and are intended to keep consumers from having mortgages they can’t afford to repay.
If you’re seeking a mortgage loan, you’ll likely hear a new term: “qualified mortgage” or “QM.” Lenders making QMs typically assess a prospective borrower’s ability to repay the loan based on certain attributes, including:
- Reasonably expected income,
- Employment status,
- Other debts,
- Credit history, and
- Monthly debt-to-income ratio, which typically will need to be less than 43%.
To analyze these, a lender might review your W-2 statements, income tax returns, and bank statements, among other documents.
The rules also ban a number of “toxic loan” features from most qualified mortgages, including:
- Interest-only periods in which borrowers pay just the interest and no principal,
- Balloon payments, although these are allowed in certain circumstances,
- Negative amortization, or loans in which the principal increases over time, even as the borrower makes payments, and
- Loan terms extending beyond 30 years.
In addition, lenders likely will be unable to determine a borrower’s ability to repay using a temporarily low “teaser” interest rate. So, if the loan is an adjustable-rate mortgage, the lender will determine your ability to repay using the highest possible interest rate.
… and there’s more
The new rules also limit the initial fees and points that can be assessed on most qualified mortgage loans. Some charges — say, to run a credit report — are excluded from the limit.
The new rules come at a bit of a cost: Lenders may find it hard to recoup the expense that the extra scrutiny requires even on smaller mortgage loans, and they may decide not to issue loans that fall below a certain threshold. Self-employed individuals, whose income often fluctuates, might be unable to show they can manage the ongoing payments.
There is an upside
If you’re thinking about purchasing a home, work with your financial advisor to learn more about how these regulations might affect the mortgage loan you can qualify for.
Sidebar: Paying cash for a new home
Having enough cash to cover the cost of a new home can put you in a prime position. Cash buyers may be able to close more quickly than those who must obtain financing, which also may get them a better deal. And cash buyers not only avoid mortgage interest costs but also may be able to reduce some costs at closing.
Even so, cash buyers should take these three steps before committing to a purchase:
1. Run the numbers.
Although using cash to purchase a property offers some valuable benefits, it also means tying up a large sum of money in a relatively illiquid asset. Before entering into a cash home deal, make sure you have enough other funds on hand to cover ongoing expenses, savings and emergencies. Also consider whether it might be financially smarter to take out a mortgage and make another investment with the money you would have put into the home purchase. As long as interest rates remain relatively low and mortgage interest remains deductible (up to certain limits), you might get a better return putting cash into investments other than your home.
2. Pay for an appraisal and inspection.
These services typically are necessary in a sale financed by a mortgage, because most banks insist on them. Although they may not be required with a cash sale, they’re still worth obtaining in most cases. An online market report can give a general guideline of a home’s value, but it won’t be as carefully prepared as an appraisal. If you skip either the appraisal or the inspection, you may wind up overpaying. And forgoing an inspection may lead to serious problems discovered after the papers are signed.
3. Obtain title insurance.
Title insurance protects against the loss of an interest in a property due to problems with the title. These can arise even after a transaction closes and may include, for instance, a mistake in the deed or a lien against the property. An owner’s title insurance policy provides assurance that the buyer has a clean claim to the property.
As always, your financial advisor and a qualified realtor can help you to determine if buying a home for cash makes sense for you.
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