Lenders, contrary to popular belief, are no longer the only decision makers when it comes to granting mortgage loans. The decision to approve an applicant’s request for a mortgage is no longer just a matter of the amount of risk a particular lender is willing to take; it is also a matter of federal law.
That’s right; the ability to make optimal mortgage lending will be substantially influenced by the impact of the new federally mandated QM rule. The QM rule attempts to ensure the borrower’s Ability to Repay (ATR) by specifying a maximum back-end Debt to Income (DTI) ratio. For a loan to remain within QM guidelines, the backend DTI must be less than 43 (43%).
The intention of the QM regulation and the DTI benchmark is to reduce lending risk, default, and loss by ensuring that the borrower can repay the loan. In particular, one objective of the law is to ensure that lender’s do not take advantage of uniformed borrowers by lending them more money than they can realistically afford to repay.
If a lender remains within the DTI guidelines, it is assumed that the borrower can repay and that the risk of default and loss has been reduced. Also, by remaining within DTI guidelines, the lender also retains recourse; that is, it can foreclose in the event of the borrower’s failure to make payments. However, the lender’s recourse may be in jeopardy if the DTI guideline has been violated, such as by funding a loan with a 46 DTI. A borrower’s DTI is determined based on volatile and speculative income and liabilities which are subject to change drastically in a rather short period of time. Even documented income from tax returns, W-2s, and other verifiable sources and liabilities obtained from credit reports and other similarly verifiable sources fluctuate as individual circumstances change. How then, would these verifiable sources of data reflect anything other than a solid and reliable predictor of an applicant’s ability to repay a mortgage loan? The DTI may not reflect the entirety of an individual’s financial picture and their ability to repay a mortgage. Life situations and behaviors are not considered in the DTI calculation and therefore, are not considered in the determination of a mortgage that qualifies under the QM rule.
The QM law creates some form of information and risk management inefficiency. Lenders are no longer able to consider factors once considered relevant, such as relaxing DTI for borrowers with exceptionally high incomes or varying DTI based upon long term employment history or highly favorable and consistent bill paying. Conversely, a self-employed individual will experience income fluctuations as the economy changes, but may be deemed as non-QM qualifying due to the reported income at the time of the application.
Then there is the issue of information reliability. Information gathered during the application process is flawed, at times, and sometimes, downright false. An investor, who may be considering purchasing a loan, may have chosen not to purchase the loan, or may have purchased the loan at a lesser price, had the true DTI been known.
The ramifications of a flawed system are numerous and significant. Lenders are using the same criteria to determine an applicant’s DTI, diminishing any competitive advantage that may have existed otherwise. The QM rule limits the ability of the lender to apply data accumulated over many years and the resulting outcomes and risks to the underwriting decision.
Further, lenders making mortgages under the assumption of QM compliance may find out that, in actuality, the “real” DTI did not in fact qualify as a QM mortgage. The lender then loses the protection offered under default provisions of QM, the applicant then has the potential to point the finger at the lender for not qualifying the borrower under the correct provisions and everyone loses.
Ultimately, homebuyers will need to be well prepared financially, administratively and emotionally. Make sure your finances are in order, know your credit score, know your DTI, have a general idea of the interest rate you will be paying, the amount of your mortgage payment…you get the picture. Do not take the process personally, understanding the various mortgage types and your ability to qualify for a loan at a particular dollar threshold will ensure that you are well prepared for potential setbacks and, ultimately, a positive outcome. Lenders, to ensure compliance with QM rules, will need to implement additional steps and practices into their qualification processes to completely satisfy these additional requirements. What does this mean overall? Both homebuyers and lenders will need to have added patience in dealing with an already a complex process.
Chief Analytics Officer, Digital Risk LLC