In the aftermath of the housing crisis, the Dodd-Frank Wall Street Reform and Consumer Protection Act was passed, in part, to prevent another housing crisis from happening in the future. The Consumer Financial Protection Bureau was formed to create rules to carry out the goals of Dodd-Frank. The Consumer Financial Protection Bureau recently released details of a new “Ability-to-Repay” rule, which aims to prevent people from getting a mortgage loan they cannot afford and a “Qualified Mortgage” rule, which will encourage lenders to offer mortgage loans with terms that are more favorable to borrowers.
Starting at the beginning of 2014, all lenders must comply with the “Ability-to-Repay” rule when lending to someone for a mortgage loan. The “Ability-to-Repay” rule will not apply to home equity lines of credit, reverse mortgages and some other loans. Under the “Ability-to-Repay” rule, lenders must take steps to ensure that the borrower will be able to repay the loan. The lender will look at your income, the things you own, whether you work, how much you spend repaying your other debts, whether you’ve had a good history of repaying debts in the past (your credit history) and how much you will be paying for expenses related to owning a home, such as real estate taxes, in order to help predict whether the loan you want will be affordable for you.
If a lender offers a mortgage that meets the requirements of the “Qualified Mortgage” rule, it will be assumed that the requirements of the “Ability-to-Repay” rule have been met and that the loan is legal under Dodd-Frank. With some limited exceptions, you will not be able to get a “Qualified Mortgage” if your debt payments, including the mortgage loan you are trying to get, add up to more than 43% of your pre-tax income. There is a limit on the fees lenders can charge for giving you a mortgage loan. Payments on a qualified mortgage will have to be high enough that you are paying the interest and some of the balance of the mortgage loan. Many of the loans that caused problems during the housing crisis were “interest-only” loans, where people were only paying enough to pay the interest, but were never paying any of the debt off. Some people had payments that weren’t high enough to even cover the interest. Therefore, the amount owed, just kept increasing, even though the borrower was making payments.
Unfortunately, I have many clients that were victims of the housing crisis. Sometimes they were talked into loans that they really couldn’t afford. Other times, the economic downturn that came with the housing market caused them to lose income, which made the mortgage payment unaffordable. Almost all of them saw the value of their homes decrease, sometimes below what they owed on the house. I also saw people turn to credit cards to pay for their normal living expenses, because so much of their income was going to mortgage payments. These things led to my clients having to file for bankruptcy. For some, it was a Chapter 7 bankruptcy to surrender the house they could no longer afford. For the rest, it was a Chapter 13 bankruptcy to get back on track with mortgage payments and get their other debts under control.
It is encouraging to see that steps are being taken to prevent a repeat of the housing crisis. While the government and mortgage lenders are part of the solution, borrowers must do their part as well. You cannot count on the government and lenders to make sure that the loan you get is affordable. It is important to create a budget before buying a house in order to find out what you can afford. You will need to consider not only your mortgage payment, but also real estate taxes, utilities, homeowner’s insurance, repairs and maintenance. Also, if you get overtime and bonuses that are not guaranteed, it is a good idea not to consider that extra income when deciding how much house you can afford.
Be sure to stick to your housing budget when shopping for a house or a mortgage loan! Even if a real estate agent or a mortgage banker says you can afford more, you know your financial situation best and you should insist on a payment that you feel comfortable with. You do not want to make a mistake that you will literally be paying on for 30 years. Nor do you want to make a bad decision that could cause you to lose your home in the future.