New Ability to Repay Rule -- What you need to know

There’s been a lot of talk both in business and money watch columns the past few days about the Consumer Finance Protection Bureau’s new “Ability to Repay” Rule.   Fellow investors, Realtors, mortgage bankers, and consumers I have a word for you:  relax!   For those in the 80% mean area of the bell curve of potential home buyers, nothing will change.

Much of this new guideline was hyped as something new and dramatic.  With a thorough reading, however, one finds there’s not much new there from current lending guidelines. Sure, it puts new restrictions on aggressive loans with interest-only provisions, negative amortization, and balloon loans.   Since mortgage underwriting guidelines were completely revamped in 2008 and numerous revisions since, these have become all but dinosaurs in most markets anyway.

The “new” rule will limit borrowers to a 43% debt ratio which is in the same ballpark as current Fannie, Freddie, VA and FHA guidelines now.  This percentage will be calculated on your pretax income.  Also, income now has to be fully documented and verified.   So, for self-employed borrowers or those with tip based income, this may be an issue.  Waiters and hairdressers need to start declaring their tips.   Self employed individuals may have to find less write offs to actually show a liveable net income.

Oh, and get this:  these loans will now have a new name.  I'm confident it is for political spin so we know Big Brother is looking out for our best interests.  They will be referred to as a Qualified Mortgage or QM.   The standards for these “new” Qualified Mortgages are as follows:

1.      (1) Points and fees will be limited to 3 percent of the loan.

2.      (2) No negative amortization or interest-only loans.

3.      (3) No balloon loans, except in certain rural areas where these types of loans are commonplace already. 

4.      (4) Loans can be for no longer than 30 years.

5.      (5) The 43 percent threshold for ARMs will be calculated based on the highest possible loan payment during the first five years of the life of the loan.

6.      (6)Creditors must verify income history via “reasonably reliable” sources.

OK, then who will this effect?

Some borrowers – particularly those, as previously stated, with hard to document income sources.  Also, it will cause those with champagne tastes on a beer budget to be more realistic and purchase something they can actually afford.   It will also make lenders tighten guidelines for any loans that resemble subprime products and for borrowers in lower income brackets.

Lenders – provisions of this rule will make lenders harder to sue for being too aggressive in lending guidelines.  The days of the “stretch” or stated income loan are gone for good.  Further, for right now with interest rates low, lenders can still make a modest profit on loans.  However, as the prime rate rises, keeping within the 1.5% cap above prime may cause lenders to make internal adjustments and tighten their belts once again.

Bottom line:  The new “Ability To Repay Rule” represents the majority of loans currently being made by major lending institutions already.  So, nothing much will change except for a small number of borrowers.  Relax, and go write some new business!