New mortgage rules that go into effect the beginning of next year are meant to avoid a repeat of the housing and credit crisis that nearly brought the economy to its knees five years ago. But the regulations also could have the unintended effect of making it more difficult for many working-class families to qualify for mortgage loans offered by major banks.
Financial institutions in the business of originating mortgages that they plan to resell on the secondary market to government-sponsored mortgage buyers Fannie Mae and Freddie Mac will have to raise their standards for approving loans. That is likely to have the biggest impact on working-class families, many of whom are struggling with consumer debt and are living paycheck to paycheck.
Regulations that go into effect Jan. 1, 2014, prohibit banks from approving mortgages for anyone whose debt-to-income ratio is higher than 43 percent.
Banks also will have to limit the fees for originating mortgages to no more than 3 percent of the loan amount, which could discourage many institutions from pursuing loans for lower-priced houses.
"If you are a bank that pretty much originates and sells your mortgages, you are now playing under these rules," said Ernie Hogan, executive director of Pittsburgh Community Reinvestment Group. "If you are a bank that originates mortgages but keeps them and holds them for 30 years, you can vary from some of these rules."
In the years leading to the historic mortgage meltdown in 2008, lenders too often made home loans to buyers who could not pay them back and ended up in foreclosure. The Dodd-Frank Wall Street Reform and Consumer Protection Act enacted in 2010 requires lenders to more closely scrutinize borrowers' financial information to make sure they can afford a loan.
Two of the most important new rules created by the Consumer Financial Protection Bureau -- which also was created by Dodd-Frank -- related to housing are the Ability-to-Repay rule and the 3 percent test rule.
The Ability-to-Repay rule, also known as the Qualified Mortgage rule, says borrowers' total debt liability -- including housing -- should not exceed 43 percent of income. A Qualified Mortgage is one that would be qualified for resale on the secondary mortgage market.
The 3 percent test rule says 3 percent of the mortgage amount is the maximum amount of fees that banks can charge a borrower in order for the home loan to be classified as a Qualified Mortgage that can be resold in the secondary market.
Mr. Hogan believes this rule will make lower-priced homes more expensive for banks because they will not make as much money on that kind of business.
"It will hurt working-class families buying homes for $75,000 or less," he said. "Those loans will be classified as a high-cost loan. You are going to lose people in the mortgage industry looking at that segment. That's what we think will happen. Banks will make a better spread on higher-priced homes."
Don Frommeyer, president of the National Association of Mortgage Brokers, said the 3 percent rule also will be a problem for mortgage brokers.
He said brokers will have a harder time collecting their fee on homes priced below $160,000 because every cost to the customer in the homebuying process goes toward the 3 percent. For a mortgage of $100,000, for example, all origination fees -- including the mortgage broker fee -- would be limited to a total of $3,000.
"Loans between $100,000 and $160,000 will be caught in the middle," Mr. Frommeyer said. "Until this is all sorted out, we won't know how the 3 percent rule will actually work."
The Ability-to-Repay rules will apply to most mortgage loans. However, they exclude certain types of loans such as home equity lines of credit, timeshare plans and reverse mortgages.
Ken Benton, senior consumer regulations specialist at the Federal Reserve Bank of Philadelphia, said the new rules do contain several options to make residential mortgage loans available for low- and moderate-income borrowers.
Certain types of lenders are exempt from the Ability-to-Repay/Qualified Mortgage rule and can make loans without regard to a borrower's debt-to-income ratio.
Those include state and local government housing finance agencies, community development financial institutions, down payment assistance creditors designated by HUD, Community Housing Development Organizations and nonprofit lenders. In addition, community banks that meet certain requirements can offer Qualified Mortgages without a debt-to-income ratio limit.
HUD has also proposed a Qualified Mortgage standard for FHA loans that will have no debt-to-income limits. HUD said it was making the proposal in order to remain consistent with the housing department's mission to serve underserved borrowers.
"We don't know at this point how banks will adjust their mortgage loans to implement the new rules that will go into effect in January 2014," Mr. Benton said. "We are not in a position to speculate on that. There are too many variables and moving parts."
According to a study by the Federal Reserve Board, 14 percent of all households that carried debt in 2010 had monthly payments higher than 40 percent of their income nationwide.
But 26 percent of households in the poorest 20 percent of the population had debt payments greater than 40 percent of their income, while only 3 percent of the richest 10 percent paid more than 40 percent of their income for debt payments.
"When one looks at the high monthly debt service to income, poorer households have more difficulty serving their debt than richer households," said Richard Fry, a researcher at the Pew Research Center in Washington. "Similarly, younger households -- 30 years or less -- tend to have lower debt service relative to income because over the last 10 years they have not been buying houses or cars as [past generations] previously had."
Mr. Hogan said although HUD is proposing that government-backed mortgages be allowed to have a higher debt-to-income limit, it still leaves private financial institutions with only two options. Either they comply with the new debt-to-income standards or keep the loan on their own books, which is harder to free capital for new home loans.
"The effect of this is unknown, but we believe banks will lean more to preserving the right to sell these mortgages. So they will conform to the Qualified Mortgage standard," Mr. Hogan said.
If that's the case, he said, "Buyers with student loans, car loans, credit cards and other fixed debt will find it harder to buy as these families pay out on average 50 percent to 60 percent of their income for housing and things."
First Published October 8, 2013 8:00 PM