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How the 2 New Mortgage Rules Affect Your Fix N Flips

by Tracy Royce on January 11, 2014 · 23 comments

  
New mortgage rules

New mortgage rules have been put into effect this last Friday to clean up, correct, and prevent the type of unscrupulous lending practices of past.

The Consumer Financial Protection Bureau is the agency that has issued the new rules, and tried to have them focus on a back to basics approach. This includes two new rules for lenders to follow: Qualified Mortgages and The Ability to Repay Rule (really, we’re just now making this a rule?).

Qualified Mortgages

A large indicator Lenders use to see whether you can truly afford a home is your debt to income ratio. It’s a basic calculation of what your monthly obligations are (student loans, car payments, credit cards, other recurring expenses), and divide it into your monthly gross income. Although it’s not a hard and fast rule, a debt to income below 43% is ideal. Banks may lend to those with higher DTI’s, but require more assets, reserves, etc, to justify taking on the risk.

Qualified Mortgages can’t have “risky features” that were used to slice and dice a loan to make it more palatable, including extending the loan term past 30 years to lower the monthly payment, having interest only payments, or minimum payments that don’t even match up with the minimum interest due. There also cannot be large upfront charges and fees that come out to more than 3% of the mortgage balance, and that even includes title insurance, points to lower the mortgage rate, and origination fees. If you’ve purchased multiple properties, you may try to aim to keep your closing costs around 2-3%. For buyers that may not have been experienced, paying large fees, points, and percentages was not unusual, and padded the pockets of opportunistic loan officers and lenders.

Ability to Repay

The debt to income ratio is going to be a strong point with the new mortgage rules. It’s really the corner stone of a borrowers ability to afford the payments for the life of the loan. If you remember, loans such as the NINA (No Income No Assets), low document loans, and other high-risk mortgages that required little, if any, verification of the applicant’s income, assets, debt, and credit. These types of instruments basically put anyone that was interested in obtaining credit into a loan, disregarding any implications.

Beyond taking the extra time to verify borrowers’ monthly debts, income, credit history, and assets, the DTI can no longer be based on low introductory rates, rather, the full monthly charges you face if any “teaser rate” expires.

What’s not stated, though, is a minimum credit score requirement or down payment. If everybody that wanted a mortgage here on out was expected to have a 720 FICO and 20% down, it may drastically reduce the amount of those that could successfully secure a mortgage for their home, especially first time home buyers.

What’s noteworthy though is no matter who you originate your mortgage with, most likely it will end up on the books of Freddie Mac or Fannie Mae, who back nearly 75% of all the nations mortgages. Currently they will not approve applicants who don’t have a score of at least 620.

These changes aren’t a surprise to Lenders, who have been expecting these changes for months. It may increase processing times, but with 30 year mortgage rates still under 5%, many borrowers are still interested in taking advantage of the low rates.

What will create a stoppage, though, is borrowers relaxing on getting out the door to buy houses. Some markets are seeing a slowing in marketing times, contracts, and closings, perhaps of a reflection as trepidation around the jobs market and curiosity of what turn real estate will take into the Spring selling season.

Related: How the Dodd Frank Act Will Impact Your Real Estate Business

Hints if You’re Selling Real Estate

If you’re rehabbing properties and selling them for a profit, chances are the majority of your new Buyers are financed. Depending on what market you’re in, your sales time may have very well slowed down, as well. The last thing you want is have an interested and committed Buyer on the line, and find out far into the process that they cannot qualify to close.

One thing I require on my sales is that if the Buyer is getting financing, they must check in with my preferred Loan Officer who works at a Brokerage (meaning, he doesn’t work with just one bank). They don’t have to have their credit pulled, but they do have to get a “soft” prequal from him in order to move forward with the contract. If they decide to stay with their own lender, and he/she can’t close the loan, we have a plan B. The Buyers agent may give you a little push back, but explaining they don’t need their credit pulled, and this could help save a deal, puts them more at ease. Many loan officers that are still in the business tend to be realistic if they can close a loan, but, I don’t like taking chances or hinging my entire deal around someone I’ve never worked and hoping they can perform.

Also, I call the loan officer for the applicant and verify the borrower is qualified (even if it says so on paper, who cares?!), and any other information that may help. I want to hear that they’re experienced, have truly vetted the Buyers, and have the confidence and underwriting team to close the loan. As lending practices evolve and shift, it gives you a way to oversee this critical portion of selling your real estate.

What do you think? Do lending restrictions need to get any tighter, or is this a ripe time to implement stricter lending practices?

Photo: SalFalko

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{ 23 comments… read them below or add one }

Brian Gibbons January 11, 2014 at 12:28 pm

OMG thanks for doing this.

I was reading a post from an ANGRY mortg professional about a client that got denied with 760 fico, 40% down, 20 years on job, and got denied for 46% DTI.

Can you friggin believe that?

Dodd Frank does help Terms REIs. Buy on sub2, sell on a straight lease and pure option. Agents will have fewer cash home buyers due to Dodd Frank.

All Problems are Disguised As Opportunities!

Tracy this is DF Article going on my Blog! Thx again!

And here is a collection of DF Articles if anyone finds them helpful. http://bundlr.com/b/dodd-frank-safe-act-respa-tila

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Trevor Western January 12, 2014 at 12:21 pm

I was denied last month by a big bank for having a 38.1% DTI, 25% down, and 771 FICO. They wanted a DTI below 38%.

Ended up going to a smaller bank with a better loan officer. Got a lower rate and faster service without any problems. Think I’ll keep using this smaller bank.

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Tracy January 12, 2014 at 2:02 pm

Thanks for the insight and the extra resources Brian. I’m sure these are going to be hot topics in the coming year.

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Roy Schauer January 11, 2014 at 12:40 pm

Thank you for sharing your thoughts and especially some of the ideas to mitigate possible problems down the road. For our company, the closing time frame is probably the longest portion of our process and can be the most frustrating due to any lack of control. Appreciate you taking the time to write it out for all of us!

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Tracy January 12, 2014 at 2:02 pm

Of course, Roy. Hope it helps!

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Justin January 11, 2014 at 1:23 pm

This will create a deflationary spiral on real estate equity, less qualified buyers equals lower prices…

Good for cash home buyers and buy and hold investors, not good for rehabbers (on the selling end) or home buyers needing financing (the price is low but can they even qualify?)…

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Tracy January 12, 2014 at 2:04 pm

We’ll see, Justin. When interest rates start to rise it actually sparks demand, but in past recoveries the desire to buy and employment levels were better than they were now. REI’s are a creative bunch and will work through this.

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Geoff January 11, 2014 at 4:39 pm

I agree with Roy, thanks for the explanation.

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Mark Ferguson January 11, 2014 at 10:42 pm

I am waiting to see if this will have a little or big effect on things. My portfolio lender said it would affect them on some deals, but not me with my rehab loans and rental loans. They said it would mostly cause more paperwork and processing. They didn’t loan to people that didnt meet the current standards anyway.

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Tracy January 12, 2014 at 2:07 pm

Agreed, Mark. Although they put these rules into play there’s been a lot more scrutiny on the lending side for years now. This isn’t anything new, really, it’s just reinforcing what hopefully will vet buyers that cannot truly afford the cost of homeownership.

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Tom Phelan January 12, 2014 at 6:30 am

Question, did the Dodd Frank Bill cover the issue of the “YSP” that for years has conveniently been off the Credit/Debit Columns of a closing statement?

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Tracy January 12, 2014 at 2:08 pm

Hi Tom, that’s a good question but I’m not familiar enough with the DF act to know off the top of my head. I wonder if @Brian Gibbons would have any insight to that.

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JB January 12, 2014 at 1:33 pm

This doesn’t affect buying subject to the existing financing does it?

How about a house owned free and clear and the seller is willing to take payments on their equity?

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Brian Gibbons January 12, 2014 at 2:50 pm

Dodd Frank has to do with Owner Occupant Seller Financing.

Home Sellers can do one a year, and in my opinion should have a RMLO underwrite the buyer, regardless, even a lease and pure option.

What is being discussed for real estate investors that buy, rehab and resell on terms (cfd, lease option, etc) that the REI use entities (Corp, Trust, etc) that own rehabbed homes to be sold on terms. What is uncertain is what “controlled groups” will be viewed by the CFPB. the enforcer of Dodd Frank (this is IRS terminology http://www.irs.gov/pub/irs-tege/epchd704.pdf)

Bottom Line:
You can buy investor to investor any way you want on terms, just tell the seller you will never live in it.
You can sell one a year anyway you want. See http://bundlr.com/b/dodd-frank-safe-act-respa-tila
If you are an agent, it may be a good idea to assist the seller with seller financing.

Here is an explanation in English…

THE ONE PER YEAR CATEGORYThe CFPB broke seller financing into two different categories. One category is for those individuals, trusts or estates who do just one seller carryback transaction a year on a property that has a dwelling that the buyer will use as their primary residence.

Let me repeat that, because there has been so much misinformation circulated about it: this category is for those individuals, trusts or estates who do just one seller carryback transaction a year on a property that has a dwelling that the buyer will use as their primary residence. For them:

* You can have a balloon in your note with the buyer.

* You do not have to prove or document their ability to repay.

* The note must have a fixed interest rate for five years, and at the end of five years the interest rate can increase no more than two points per year with a cap of six points above whatever you started at. You have to tie it to an index like a T-bill or the prime rate in the beginning.

That’s probably going to affect all but three to five percent of individuals who carry back notes.

Remember that these restrictions only apply to seller-carryback transactions on properties that have a dwelling that the buyer will use as their primary residence. A transaction on a lot or vacant land is exempt, even if the buyers plan to build a primary residence.

If the property has a dwelling, but the buyer is not going to use it as their primary residence — say they’re going to rent it or use it as a second home — then none of this applies, and you can offer seller financing with no restrictions.

Commercial property and multifamily that is five units or larger is also exempt from the restrictions.

Again, the one seller carryback transaction per year category applies to individuals, trusts and estates. It does NOT apply to corporations, LLCs, partnerships or other legal entities. In that case the second category applies (below).

Again, these rules only apply to what the CFPB refers to as a residential mortgage loan where the note is secured by a dwelling or residential real property that includes a dwelling.

Most people only carry back a note once in their lifetime, when they sell the big house, retire and move somewhere else. Some might do it a few more times. Even many real estate investors only do it once a year. These regulations are not a huge change for most people.

THE MORE THAN ONE PER YEAR CATEGORYThe second category applies to individuals, trusts and estates that do more than one seller carryback transaction per year when the buyers will use the dwelling as their primary residence.

It also applies to any seller-carryback transaction — even one — where the seller is a corporation, LLC, partnership or other legal entity and when the buyers will use the dwelling as their primary residence.

* The note cannot have a balloon.

* The note must have a fixed interest rate for five years, and at the end of five years the interest rate can increase no more than two points per year after the fifth year with a cap of six points above whatever you started at. You have to tie it to an index like a T-bill or the prime rate in the beginning. This is the same restriction as the first category.

* You must determine the buyer’s ability to repay.

* If you do no more than three seller-financed transactions per year you do not have to become a Mortgage Loan Originator (MLO).

* If you do more than three you must become an MLO — or find an MLO who is willing to be the go-between.

Just as in the “one per year” category, these restrictions only apply to seller-carryback transactions on properties that have a dwelling that the buyer will use as their primary residence.

If you have a rental house and the renters want to buy the house to use as their primary residence, and you want to carry back a note with a balloon (and you don’t do more than one seller carryback transaction per year), and that rental property is in a corporation, LLC, partnership or other legal entity, you’re going to have to move the property into a trust or into your personal name. Otherwise, you’re going to fall into the second category which says you cannot have a balloon unless you are an individual, trust or estate.

If you think about it, not having a balloon but being able to do an adjustable rate almost serves the same purpose. Let’s say you start out with an interest rate of 6% on the note and then after five years it goes to 8%, then it goes to 10% and then it goes to 12%. That’s a huge incentive for the buyer to refinance out of the property and pay you off. If they don’t, then you’re rewarded for your risk in carrying that paper; you’re now getting 12% for holding that paper, and there is no balloon.

ABILITY TO REPAYThe second category requires you to determine the buyer’s ability to repay, but the rules and the regs don’t specify any standards for doing it (such as the qualified mortgage standard, a 43% debt to income ratio, etc.). You don’t have to do any of that; you can just ask them if they have a job, can you see a paystub, can you see their tax return (which they may or may not give to you). All you are required to do is to make some good-faith determination that they’re able to afford that payment, and you do not have to document it.

It would be prudent to have some documentation in case there’s a default and the buyer’s attorney says “where’s the documentation?” and tries to create a legal defense against paying you. But there is no requirement that you have to document. All it says is that you should determine the buyer’s ability to repay.

I asked an attorney at the CFPB about how one should determine the buyer’s ability to repay. He said that if you fall under category two you have to determine the ability to repay, but he admitted that there are no set guidelines. You just have to show that you used good faith in determining, for example, that the buyer has a job, his rent was $1,000 per month, but the payment on the note is $900 a month and you think in good faith he can afford this property because he could afford the rental house he was in before.

WHEN YOU’RE BUYING A NOTE CREATED ON OR AFTER JAN. 1, 2014You’re going to be able to tell from the note if the mortgagee is a private individual or an entity. If it is a private individual, trust, or estate, then ask them to sign an affidavit saying that they have not done more than three of these in a 12-month period and how many of them had balloons. If it’s an entity, an LLC, or a corporation, etc., ask for an affidavit saying how many it has done and how many of them had balloons.

If there is a balloon in that note that you’re buying from an LLC, corporation or partnership, etc., you know there’s not supposed to be one (again, if that note was created on or after January 1, 2014). You’ll have to have the note modified to remove the balloon before you buy it. Otherwise at some point the mortgagor could use the fact that the note was not in compliance when it was written as a defense against paying the debt or foreclosure.

One more thing — I want to thank Bill Mencarow and PAPER SOURCE JOURNAL subscribers for getting the word out there, because, honest to God, without those comments we would be stuck with the original statute — which would have killed seller carrybacks.

In the Federal Register the CFPB wrote that they relaxed the rules on seller financing because of the numerous comments they received.

Ric Thom

Website: http://www.securityescrownews.com

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Shaun January 13, 2014 at 10:46 pm

Holy extensive reply Batman!

Thanks Brian that was some great info.
Really solidified the points Tracy was making.

It does seem like a lot of confusion about BUYING with seller financing. Lots of investors clearly have been lead to believe this will be an issue. Glad to see such definitive statements that is not the case.

Since selling on terms has not been a part of my business I’m not really concerned about DF. At least not directly. I do have the concerns in the article about the possibility of it messing with my retail buyer on fix and flip deals.

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Tracy January 14, 2014 at 8:18 pm

Brian, thanks for the extensive information. I really find the commentary under the blogs helps the readers just as much as the blogs themselves.

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Bill January 12, 2014 at 9:40 pm

JB – It doesn’t affect you when BUYING “subject to.” You can buy all day long with no problems. DF would affect how you could sell after you buy.

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Manuel Varela January 12, 2014 at 3:13 pm

Does anyone know how many loans someone ca have? Is it as many as you can qualify for or a defined number of loans? I’ve heard someone say you can only have 5 loans, some say 10…any insight would be greatly appreciated.

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Tracy January 14, 2014 at 8:21 pm

Manuel it will depend on many things. Often times once you’ve tapped the number of properties you can own through traditional lending guidelines, you can often find a portfolio lender in your area that will give you additional mortgages. Talk to a few mortgage professionals and portfolio lenders around you if you’re purchasing quite a bit of property and need the leverage.

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Chris Sanchez January 15, 2014 at 5:36 pm

Excellent article, Tracy. Big changes have seemed to be the norm these past few years.

All the regulations are great for consumer protection – especially on owner occupied properties. Getting a loan that a borrower ‘actually’ qualifies for should be obvious, but we all know people who overextended themselves when financing was too accessible.

To answer your question, I don’t think the guidelines need to get any tighter at this point. The CFPB and real estate bureaus have already upped the ante for increased accountability on the brokers and lenders.

It will be interesting to see how 2014 pans out overall.

– Chris

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Tracy January 17, 2014 at 11:17 am

Agreed Chris. Will be interesting to see what failures that have already been band-aided over cause the next housing collapse, though. No amount of legislation can halt another recession….It will happen!

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Dave January 16, 2014 at 11:09 pm

In regards to Dodd-Frank’s impact on Lease Options, how will the up front Option Fee be treated? Can this trigger a violation of some sort? Or should the number be kept down under 5 even if the deed never transfers? Thanks!

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Bill January 17, 2014 at 12:04 am

Dave, if your transaction is a TRUE lease and option (and not a “disguised sale”) there is no impact. A lease and option is not considered seller financing under the Act. The non-refundable option fee is treated the same: it will be applied to the purchase price at closing. There is no need to limit the number of your lease option transactions.

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