Could New Lender Regulations for 2014 Affect Your Qualifications? Part 2

debttoincomeAs was mention in Part 1, The Dodd-Frank Act, going into affect January 10, 2014, is going to change the way lenders do business through the loan applicant’s ability to repay (ATR) and the guidelines for qualified mortgages (QM) . There are two types of QM’s, general and temporary.

What are the definitions?

A general QM is the most restrictive of the two. It has all the requirements of the universal QM, mentioned in Part 1, but has the added restriction of a qualifying debt-to-income (DTI) no greater than 43%. What is DTI? Well, to put it simply, it is a key figure used during the mortgage approval process.  DTI is the percentage of a loan applicant’s monthly gross income that goes toward paying debts. This helps the lender find out if an applicant’s income can absorb the new debt by considering their existing debt. Up until now, most lenders approved loans with debt-to-income percentages up to 45%, and in some cases, as high as 50%. After January 10, 2014 this will no longer be allowed under a general QM.

Loans eligible for delivery to FNMA, FHMLC, FHA, VA USDA or VHDA will be granted QM status under the temporary definition.  A temporary QM must have all the requirements of a universal QM, with the addition of all underwriting requirements and guidelines of the applicable agency. They do not, however, require a 43% DTI threshold.

Why is it called a temporary QM? For the simple reason that the temporary definition will cease to apply to any loan after January 10, 2021.

Will this pertain to every loan you apply for?

The answer is no. There are some types of loans where the ATR/QM does not apply. They are as follows:

  • Open-end credit plans (HELOCs)
  • Timeshares
  • Reverse Mortgages
  • Temporary and bridge loans (12 months or less)
  • Initial phase of construction loans (12 months or less)
  • Loans secured by vacant land

Note: Renovation loans are still subject to ATR/QM

So, after reading all of this information you are probably asking “How is this going to affect my ability to secure financing for a home purchase?”

That depends. Managing your DTI from the start is paramount. Limit your debts if you are planning to finance your home purchase. The earlier you do this, the better! This can be difficult for those who are self employed. Any business debt, taken on by someone who is a “Sole Proprietor” (their business is not incorporated), will be considered personal debt during the loan qualifying process. If your DTI is too high there a couple of ways to lower it. First, raise your income. You can work overtime, ask for a salary increase, apply for a higher paying position or take on a part time job. This will only work if your debts do not increase as well! Secondly, you can work harder at paying off your debts. Pay a higher amount than the minimum payment due. This will increase your DTI at the onset because a higher percentage of your income will be going toward your debt. However, once your debts are paid off your DTI will drop to 0%.

Note: It is important to speak with a knowledgeable financial adviser or lender before trying these two methods. A professional can tell you what is the best way.

Is it really that simple?

Just remember, a high DTI cannot be repaired overnight. That is why planning ahead is essential. Find out what your debt-to-income ratio is way before you are ready to apply for a loan. Work with a professional to learn the best way to eliminate your debts and become a strong candidate for a mortgage.

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