A new regulation proposed by the Federal Housing Finance Administration, overseer of secondary market leaders Fannie Mae and Freddie Mac reveals that the government is still looking for ways to minimize risk following the mortgage meltdown of the past few years.
To avoid receiving loans at risk of foreclosure within securities packaged by banks, the FHFA intends to make it harder for borrowers to qualify for those loans in the first place.
Here’s how it works. Banks originate mortgage loans with borrowers who meet current qualifying guidelines for income and debt. Once they close, these “qualified residential mortgages” are eligible for purchase by Fannie Mae or Freddie Mac as a secondary-market investment. When Fannie or Freddie agrees to buy the loans, the bank is paid back the money it loaned to consumers, and it’s this money that is made available to future borrowers.
The secondary market makes it much easier for banks to make loans, as they aren’t so dependent on deposits for cash flow. But with stricter guidelines on the horizon, fewer borrowers will be able to obtain a conventional loan in the future.
Federal agencies including the FDIC and the Office of the Comptroller of the Currency, the Federal Reserve, HUD, the Securities and Exchange Commission, and the FHFA are close to hammering out a new definition for the qualified residential mortgage. At the present time, the definition will apply only to loans eligible for purchase by Fannie and Freddie, but the definition could also be adopted by government guarantors of conforming loans.
In early April 2011, the FDIC, which guarantees savings and deposits in its member banks as a safety measure for consumers, released its idea of what the qualified residential mortgage should look like.
While consumers should rejoice over such provisions as no prepayment penalties and a 6% rate increase over the life of the loan for adjustable rate mortgages, other guidelines are daunting, including:
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20% down payment for purchase mortgages with no second mortgages, effectively eliminating private mortgage insurance that allows borrowers to qualify for larger mortgages they wouldn’t get otherwise
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75% instead of 80% loan-to-value for refinances, meaning that refinancing homeowners must have 25% equity in their homes to qualify.
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No stated income loans, a hindrance for the self-employed, who qualify only with taxable income, not the gross before deductions
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Debt to income ratio of 26/38 as opposed to the mid-2000s standard of 31/41. That means that no more than 26% of income can go toward housing costs, or 38% including other revolving debt such as student loans and credit card payments.
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Borrowers can not be more than 30 days past due on any note, or more than 60 days past due within two years of applying for a conventional loan.
These guidelines are called risk retention rules, and they are set to go into effect following a 60-day comment period, and it’s likely the other government agencies will go along.
When mortgages are more difficult to get, housing prices fall, but mortgage interest rates don’t necessarily follow, especially in an inflationary environment.
If your income and debt don’t meet these new guidelines, talk to your mortgage lender now for advice on how you can improve your credit picture.
Editor’s Note: The deadline for public comment on the proposed QRM rule has been pushed to August 1, 2011. For additional information and NAR’s position on this critical issue, click here.
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