Oct. 1, 2013, 6:01 a.m. EDT

Tighter mortgage lending rules coming

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By Anya Martin, MarketWatch

Some buyers shopping for a luxury home are hoping to close the deal before Jan. 10. That is when new rules are scheduled to take effect that will tighten lending standards.

Issued by the Consumer Financial Protection Bureau (CFPB), the changes are designed to curb loose practices that triggered the real-estate meltdown. Under these new regulations, lenders are encouraged to underwrite only “qualified mortgages” that meet the tougher standards. Those that don’t could face a lawsuit from borrowers if they default on the loan down the road.
Essentially, borrowers in 2014 will receive little leniency when digging out tax returns and documenting assets and potential earnings, says Tom Wind, executive vice president of residential and commercial lending at national lender EverBank Financial Corp. /quotes/zigman/9846834/quotes/nls/ever EVER -0.95% “From an industry perspective, most lenders are going to say, ‘If I’m going to take on additional risk, I need to be even more careful who I lend to,’ “ he says.

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The rules apply even to high-net-worth borrowers who have a long-standing relationship with a bank—borrowers who have enjoyed more lending leeway, says Guy Cecala, publisher of Inside Mortgage Finance, an industry publication.
The CFPB doesn’t itemize exactly what information lenders must collect, but rules are specific about the borrower’s debt-to-income ratio, which looks at monthly debts as a percentage of gross monthly income. Starting in January, borrowers can’t have a debt-to-income ratio above 43%. This requirement may affect self-employed entrepreneurs who may show wide income fluctuations on tax returns, says Mathew Carson, a mortgage broker at San Francisco-based First Capital Group.
Carson has started discussing the impact of tighter documentation with his preapproved customers should they not be under contract for a new home before year’s end, he says. The changes will pose challenges mostly for people at the low end of the jumbo spectrum—above $417,000 in most markets and $625,000 in high-price areas.
Many banks—especially those that hold customers’ jumbo loans on their books—already have tight standards. Jumbo borrowers are typically required to put at least 20% down, which isn’t mandatory for borrowers of conventional loans. Jumbo borrowers also face a higher bar for credit scores and loan-to-value ratios than conventional borrowers.
The higher standards are attractive to investors who buy mortgage-backed securities, which are loans that have been bundled and sold to other institutions or the public. Before 2008, the majority of jumbos were securitized; now, just 7% of the entire $220 billion volume of 2013 jumbo mortgages is expected to be securitized, according to Inside Mortgage Finance. Lenders that do securitize loans will be required to hold 5% of their mortgage values on their books for the term of the loan under the new rules.
Lenders will be allowed to issue non-qualified mortgages after the rules kick in. But investors may be reluctant to buy them on the secondary market, Cecala says.
Initially, some thought tighter rules would prompt lenders to completely abandon interest-only jumbos, which can be higher risk because the borrower doesn’t repay any principal for a set period. However, the disappearance of interest-only jumbos now seems unlikely because “they are very popular with well-heeled borrowers looking at big jumbo loans,” Cecala says. About 15% to 20% of current jumbo originations are interest-only loans, he adds.
TD Bank sees the changes as an opportunity to increase its market share, says Michael Copley, retail-lending director at TD, which operates from Maine to Florida. The bank offers interest-only products only to its high-net-worth customers who can prove financial stability. “Some institutions may walk away from interest-only mortgages, but we are quite bullish that we think it’s going to be a differentiator for us,” Copley says.
A few more considerations for jumbo borrowers in 2014:
Shop features, not just rates. Rates may become a less-important determining factor than other terms of the loan, Cecala says.
Don’t inflate. Legal consequences for a bad loan will run both ways, and a borrower who misstates income or the home’s condition will risk being charged of mortgage fraud.
More regulations down the road. The CFPB is also overhauling good-faith estimate and truth-in-lending disclosure documents with an aim to merge them into one consumer-friendly document. These forms spell out the terms of the loan and actual costs incurred at closing. “That’s something else lenders will have to wrestle with in the middle or end of 2014,” Cecala says.

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