Unless you’re into reading the minutia of federal legislation, you are probably like most consumers and are unaware of a new mortgage lending rule that is slated to go into effect in January 2014. Born of the Dodd-Frank Wall Street Reform and Consumer Protection Act, lenders and consumers should anticipate the implementation of the “Ability-to-Repay” rule early next year, including its provisos related to qualified mortgage criteria. The new rule, like all other mortgage legislation of late, aims to protect borrowers and the real estate market from abuses and another housing collapse.
The idea behind the new rule is simple enough. In order to avoid abusive practices that harm consumers by obfuscating the true costs of a mortgage, the rule prohibits lenders from offering low or no-documentation loans that mask a mortgage’s true costs. Lenders will instead be required to ensure that borrowers can repay any mortgage offered to them – i.e., the “Ability-to-Repay”. Intuitive enough, right?
The “Ability-to-Repay” rule also defines a new loan category known as the “qualified mortgage”. These are a somewhat new financial beast designed explicitly to comply with the new repayment rule. The legislation requires that qualified mortgages adhere to the following criteria:
1. Qualified mortgages cannot have interest-only periods;
2. Qualified mortgages cannot have negative amortization;
3. Qualified mortgages cannot exceed 30 years;
4. Qualified mortgages cannot have balloon payments at the end of the term, with a limited exception for those living in a rural or underserving areas (although who defines that I’m not sure);
5. Qualified mortgages cannot exceed forty-three percent (43%) of a borrower’s monthly pretax income; and
6. Borrowers must provide proof of income or assets.
While these new rules may be good for consumers by stabilizing the housing market and minimizing the chances of a further collapse, the “Ability-to-Repay” rule is likely to have a chilling effect on at least one segment of the population – self-employed individuals. For better or worse, those who are self-employed often have uncertain, seasonal and/or fluctuating income. Under the best of circumstances in the current system, lenders are often hesitant to lend to these individuals. While more of a challenge to secure financing, lending for these individuals has, at least for the most part, traditionally been available.
So, what impact will these new rules likely have? The rules of the game are already stacked against the self-employed because of their often uncertain income. The “Ability-to-Repay” rule takes that burden and significantly heightens it by applying stringent criteria to get a qualified mortgage. Unless the applicant can demonstrate stable or increasing income, his or her chances of obtaining a mortgage may be poor. Under the new rules, it’s unclear whether and how much leeway lenders might have to make business decisions about making loans. As a matter of practicality though, I wouldn’t bank on lenders going out of their way to accommodate applicants who have anything other than a pristine record. It light of the present economic and political culture, I would wager that few if any institutions are willing to assume the risk of running afoul of the administration or this new legislation.