Big Changes Coming to Mortgages, and How to Get Ahead of Them


By Scott Sheldon

Recently, there had been speculation among real estate and financial professionals that conforming mortgage loan limits would be lowered, meaning homebuyers may have less borrowing power. And in fact, acting director of the Federal Housing Finance Agency Edward DeMarco announced on Oct. 24 there would likely be a decrease in mortgage limits, but not until spring 2014. The mortgage limits will be announced in late November. Beyond this, there are many other changes coming to mortgages in the next six months, so let's take a look at how they'll affect homebuyers.

1. Qualified Mortgages: In January 2014, in accordance with the Dodd-Frank Act, "qualified mortgages" will be introduced to the industry as a new way of conducting home mortgage loan origination. Under the law, a qualified mortgage is a fixed-rate mortgage, with a debt–to-income ratio (including the proposed mortgage payment) that does not exceed 43 percent of the borrower's gross income. If the loan is otherwise adjustable or the debt-to-income ratio exceeds 43 percent, the loan becomes a "non-qualified mortgage."

No matter what bucket, the consumer must provide full supporting financial documentation, and the lender and consumer have to acknowledge a full employment and income analysis. Many of the loans being underwritten today, including the conforming loans offered by Fannie Mae and Freddie Mac, contain debt-to-income ratios of 45 percent, and in many cases even higher. Qualified mortgages will have an effect on how loans are originated, but more importantly they could also push consumers into higher-cost mortgages.

2. Housing Recovery & Risk-Based Pricing: We are not in the land of free-flowing credit -- yet. Credit overall is still rather tight, and risk-based pricing is ever more prevalent. Risk-based pricing essentially refers to the practice of issuing higher-cost loans that are given to riskier borrowers.

For now, until risk-based pricing is reduced industry-wide, the loan limits are supported at their present levels ($417,000 for conforming loans and up to $625,500 in some markets, for conforming high balance loans backed by Fannie and Freddie). An example of risk-based pricing would be extra percentage points being charged on the amount borrowed by someone with a lower credit score -– such as a 0.5 percent point for a 680 credit score. On a $400,000 mortgage, that's a $2,000 closing cost.

Keep in mind, loan-level pricing adjustments can drop in time, as credit becomes more openly available. However, make no mistake, while in many markets foreclosures and short sales are dropping, the housing market as a whole has still not fully recovered -- as evidenced by the continual tightening of credit, especially in the mortgage arena. The good news is that this is likely the last of the limiting changes brought on by the need for strong credit, meaning this is the first step on the road to long-term recovery.

3. What Loan Limits Could Mean: Should the Federal Housing Finance Agency reduce the loan limits for Fannie and Freddie loans, borrowers could be forced into higher-priced loans, aka jumbo loans, which contain higher rates and higher associated fees. Jumbo loans cost more because there's a smaller pool of investors in the secondary market buying these mortgage-backed securities. Due to the sheer nature of a lower appetite for and the perceived risk of jumbo loans brought out by the credit crisis a few years back, it has investors skittish on lending large amounts of money to borrowers with less-than-stellar credit.

Consider this: Securing a jumbo fixed-rate loan requires a down payment of at least 20 percent, and most jumbo lenders are pricing anywhere from 0.75 to 1 percent above Fannie/Freddie conforming loans. Reducing the loan limits for the higher loan-limit type borrower forces them to take out higher-priced loans, creating a decreased loan volume in the secondary mortgage market.

There is a possibility that, due to a reduction in loan limits, jumbo loan investors could start to come back into the market and aggressively price loans to capture the additional business. Only time will tell.

How the financial markets price risk in the new year will dictate the likelihood that the FHFA will reduce conforming loan limits come spring 2014. Because large-scale changes typically take months for the effects to be known, it's still possible that loan limits will not be reduced in the coming months.

If you're considering refinancing a mortgage or purchasing property, if possible, get qualified with a lender now, even if you don't plan to purchase right away. Doing so will allow you to get the full perspective of how your qualifying ability could be affected in 2014.

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