A few things happened to the housing market after the pandemic: Mortgage rates fell, demand for housing increased, and the availability of credit declined.
Potential buyers and people who wanted refinance their existing mortgages facing stricter approval standards than the days before the pandemic. Some banks feared the economy might collapse, so many raised the bar on who could get a loan, especially Federal Housing Administration (FHA) loans.
For many first-time borrowers or those with lower credit scores, these higher qualifications have left them completely out of the game. But there are two things happening right now that may give some borrowers reason for hope:
- Lenders expand the availability of credit and
- The Consumer Financial Protection Bureau (CFPB) is relaxing borrower standards so more people can qualify for a mortgage.
Mortgage lenders make credit more flexible
The availability of credit has increased over the past three months as the economy continues to improve. Financial institutions predict that 2021 will support, to some extent, the feverish credit activity of last year (certainly for purchase loans and, to a lesser extent, for refinancing loans, such as rates should increase).
This is because lenders are not only expanding the availability of credit, but they are also expanding their lending options, such as offering adjustable rate mortgages (ARM), according to Joel Kan, associate vice president of economic and industrial forecasting at the Mortgage Bankers Association (MBA).
“Despite ARM loans representing a very small share of loan applications in recent months, lenders are probably expecting a strong home buying season by expanding their product offering,” he said.
“The continued strength in home buying demands and home sales continues to signal robust housing demand, although low housing stock remains a constraint.”
Yet even with lenders offering more credit to borrowers, “the credit supply is still at its tightest level since 2014,” Kan said.
Most experts agree that there is still room to expand access to credit, especially as unemployment rates keep dropping and Covid-19 vaccines are rolled out.
The CFPB and the “Qualified Mortgage”
This is where the CFPB comes in. As the regulator of consumer financial products, the CFPB is leading the way in establishing responsible lending rules. In December 2020, he published two final rules which would change Qualified Mortgages (QMs) and create a new category of QM loans. The rules were due to come into force in July, but the CFPB is expected to request a delay to possibly review their implementation.
A qualified mortgage is essentially a mortgage that meets a prescribed set of CFPB standards, designed to protect borrowers against risky loan characteristics (think lump sum payments) and ensure that borrowers are able to repay the loan.
Although quality management requirements are designed to protect borrowers, most consumers are unaware of them because they are industry regulations used to ensure that lenders treat consumers fairly. Quality management rules prohibit things like excessive fees or unusual terms that could compromise the borrower’s ability to repay the mortgage or even understand the loan.
For lenders to sell their loans to Government sponsored companies (GSE), their mortgages must meet QM standards. Non-QM loans are not eligible to be sold to GSEs. Non-QM loans are not necessarily riskier than QM loans, they simply do not meet the requirements for QM loans. Jumbo loans and interest-only loans, as well as loans that consider alternative income documents (which independent consumers could use) are examples of non-QM loans.
This is important because banks and mortgage lenders depend on GSEs to purchase the loans they make, which accounts for around 70% of all mortgages.
Rule 1: The General Final Rule of Quality Management
The first rule is called the “final general rule of quality management”, which replaces the current requirement that the debt to income ratio (DTI) is equal to or less than 43%.
Rather than using the DTI, the new rule states that in order to qualify as QM, a borrower cannot have an interest rate greater than 2.25 percentage points above the average prime rate (APOR), the interest rate granted to the most creditworthy loans. For example, if the APR is 3%, then a borrower will have to qualify for a rate not exceeding 5.25%.
Since some borrowers might have a DTI above 43%, the new change will give them the ability to qualify for a mortgage without being limited (by the government, anyway) by how much they owe.
Additionally, the new QM rule removes some guidelines on how to document a borrower’s income and debts. The CFPB says this will provide “more flexible options for creditors to verify a consumer’s income or assets.” As a result, gig workers, independent contractors, and independent borrowers might have a better chance of qualifying for a mortgage.
Some experts argue that the CFPB is doing a dangerous move
Not everyone thinks this is a responsible decision. The American Enterprise Institute (AEI) Housing Center, a right-wing think tank, called the quality management rule “dangerous,” saying in a report that “the PPA does not accurately capture risk, could be subject to gross manipulation and would not provide any friction to slow down unsustainable levels of home price appreciation during a housing boom. “
AEI Housing Center Director Edward Pinto says risk overlay is a better alternative to eliminating a DTI requirement altogether. Risk stratification would take into account several financial factors and balance them with each other.
For example, someone may have a high DTI but a good credit score and a advance payment, which would help to balance the risk. As the new rule currently stands, someone with a high DTI, low down payment, and average credit score may qualify for a mortgage.
“The mortgage industry will have its origins in whatever it can get out of it. As long as Fannie [Mae] will buy their loans, they will make them. They are indifferent to the rules, ”says Pinto.
Without tighter safeguards in place, the mortgage industry is putting itself in a dangerous position, especially in a sellers’ market, critics say. If obtaining a mortgage became easier, it would not only be risky for the economy, there would be more demand, which would continue to drive up prices.
“We estimate that this policy change could increase the level of leverage available to GSE homebuyers by approximately 20%. This is particularly dangerous in a sellers market, where additional demand will be capitalized into higher house prices, ”according to the report.
Rule 2: Seasoned QM
The second rule establishes a new category for QMs called “seasoned QMs”. These are mortgages that were not initially considered to be QM mortgages, but after three years of one-off payments and specific eligibility conditions, they can be acquired as QM mortgages.
Allowing lenders to switch from non-QM loans to QM loans after three years opens up opportunities for borrowers who might otherwise have been denied a mortgage. For lenders, this is an additional tool that they can use when evaluating loans and analyzing risks.
To qualify as a seasoned QM, the loan must be held in the lender’s portfolio for three years (a 36 month supply period) and meet performance and portfolio requirements.
However, there is no provision in the new category that prohibits lenders from discharging these loans before the expiration of the three-year period. The CFPB did not respond to a request from Forbes Advisor.
New rules could help “marginal households”
Industry groups like the MBA praise CFPB’s efforts to include income outside the traditional territory of salaried employees, which would be useful for concert workers, independent contractors and business owners.
“Revisions to these rules will preserve and expand responsible access to affordable credit while retaining basic consumer protections. In particular, these rules remove onerous requirements for non-traditional income sources and expand consumer choices, ”the MBA said in a statement.
Likewise, Ralph B. McLaughlin, chief economist and senior vice president of analysis at Haus, a fintech firm, says removing the DTI requirement could help indebted consumers access mortgages. without necessarily compromising their financial security.
“This will likely lead to greater availability of credit for households that have a lot of debt but have managed that debt responsibly,” McLaughlin said. “Overall, this should help some marginalized households access homeownership while increasing the flexibility of origination among lenders.”
These two rules would have massive impacts on the housing market. They would likely help “racial and ethnic minorities, first-time buyers, households with limited means or others who are not eligible for government-backed loans, including the self-employed and workers in the economy. gig with non-traditional sources of income, ”according to the Urban Institute, a left-wing think tank.
The report shows that people who have paid their mortgage on time for at least three years are more likely to continue to do so. Therefore, while the Seasoned QM rule may carry some risk of default, there is a good indication that borrowers will not default on their mortgage.
“Mortgage market experts agree that the availability of credit for people of color and those with limited incomes remains limited by historical standards. We also know that increasing access to credit, by definition, means accepting a higher probability of default. The question is whether the increase in home ownership is worth the additional default risk, ”the report says.