The Consumer Financial Protection Bureau (CFPB) is planning to make some changes aimed at widening the accessibility of mortgage loans by allowing lenders more freedom in determining a borrower’s ability to repay. Currently, one of the requirements for a qualified mortgage (QM), the loan type preferred by both lenders and consumers, is a debt-to-income ratio of no more than 43%. This criterion is designed to be an indicator of the borrower’s ability to repay. However, there are other methods of determining this that can broaden the range of QMs. The CFPB’s solution is to compare the loan’s annual percentage rate (APR) to the average prime offer rate (APOR). Because a borrower with a high DTI would likely also have a high APR compared to APOR, DTI considerations are still indirectly included, but there will also be people with a high DTI but low risk of default that are able to get a good APR to APOR ratio and therefore successfully get a QM loan.
There are two types of mortgage loan insurance, and it’s also possible to avoid needing insurance. Mortgage insurance premiums (MIP) are the type of insurance required by the Federal Housing Authority (FHA). The other type is private mortgage insurance, or PMI. It’s easier to qualify for FHA loans, but private loans come with some additional benefits if you do qualify. Most notably, it’s only PMI that you can avoid; if you only qualify for an FHA loan and not a private loan, MIP can’t be ignored.
Private lenders generally have stricter credit score requirements than the FHA. In return, the higher your down payment, the lower your premium amount. Furthermore, if your down payment is at least 20%, you aren’t required to get loan insurance, so you avoid paying PMI. If you’re getting an FHA loan, you’re stuck with MIP for at least 11 years. On the bright side, the down payment amount to qualify for a reduction to 11 year MIP is 10%, not 20%.
Generally, the greater you can make your down payment, the better. Of course, paying all cash to avoid a loan at all is ideal, but not everyone can afford to do that, so keep in mind the important breakpoints. If you qualify for a private loan, putting at least 20% down is probably your best bet. Even if you only qualify for an FHA loan, be sure to put at least 10% down so that you aren’t stuck with MIP for the entire duration of the loan.
The Federal Housing Finance Agency (FHFA) announced in August that it would be charging an additional refinancing fee to offset losses due to COVID-19. The new fee was expected to come into effect yesterday, September 1st, but at the last minute, the FHFA rescheduled it to December 1st. We’re still in the midst of a recession, so the FHFA doesn’t want to make too many changes too early.
The new fee exempts refinance loans with balances below $125,000, affordable refinance products, Home Ready, and Home Possible. Applicable loans, which are cash-out and limited cash-out refinance loans, will have 0.5% added to each transaction. While this fee applies directly to lenders, it also indirectly affects borrowers in the form of higher interest rates. While the FHFA certainly wants to recoup their projected $6 billion in losses, they’ve agreed that now is not the time; the economy still needs to recover first.
I’ve previously mentioned that COVID-19 and the current economic downturn have resulted in an increase in mortgage forbearance requests. But what about mortgage applications? Interestingly, even as fewer people are able to pay their mortgages, people are still applying for mortgages, looking to take advantage of the current low interest rates on mortgage loans. And getting rejected at a much higher rate.
Lenders will always want to ensure that people are able to pay back the money they borrow. Obviously if the borrower has a mortgage in forbearance, well, that borrower doesn’t stand a great chance of being able to pay back a new mortgage. But even beyond that, lenders have been tightening restrictions in the wake of lessened economic stability. They are requiring higher credit scores, larger down payments, and more savings. Someone who was largely unaffected by the economic downturn may think they have a good chance at getting their mortgage loan approved. Not necessarily, if they were basing their expectations on old lender restrictions. Lenders are going to need to find the right balance between encouraging borrowers — since that’s how they make their money — and avoiding risky lending practices.
Record-high unemployment since the Great Depression is worrying for people looking to buy a home. And it’s true that it’s very difficult to buy a home while unemployed, since lenders are are looking for stable income. Unemployment income is considered temporary income, which lenders aren’t going to look at. Even once you find a job again, lenders typically want two years of continuous employment. Gaps in employment older than two years don’t impact your chances of lending negatively, though, so that won’t be a concern in a long run.
Another problem is that lack of income could put a strain on your credit score. While you will eventually become employed again, changes to your credit score can be much harder to erase. In order to maximize your chances of getting a loan in the future, you should do as much as you can, starting now, to keep your credit score intact. Always make minimum payments if possible. Ask your landlord and credit companies about other payment plans, deferment, or forbearance. Cut back on unnecessary spending. The good news is that even if your credit score does take a dive, once you’ve settled the debts and start to rebuild your credit, it shouldn’t take too long to get your credit score back up — roughly six months to year, meaning you may have already recovered your credit before lenders will consider your employment to be stable.
Data has been showing that forbearances on mortgage loans have been trending downwards in June from the peak on May 22, albeit at a slow rate. However, this doesn’t tell the whole story. The downward trend totalling 158,000 is almost entirely from loans backed by Fannie Mae or Freddie Mac or FHA/VA loans. Loans backed by banks or private securities are actually up 6000.
This trend points to trouble particularly for self-employed borrowers. Even with some people returning to work or working from home as lockdowns are phased out, in an uncertain economy, self-employed people don’t have the same reliability of income. Most private loans are held by self-employed workers. Without a stable income, self-employed people aren’t certain whether or not they’ll be able to pay back their mortgages until the economy re-situates itself, so more of them are requesting forbearances.
Beginning in 2019, Fannie Mae and Freddie Mac will increase their conforming loan limit by 6.9%, matching the percentage increase in average home values nationwide. In most of the country, the limit will be $484,350, higher in more expensive areas.
Besides conforming loans, there are also jumbo loans — those that do not conform to this limit. While these are currently cheaper than conforming loans, it’s much easier to qualify for a conforming loan. And the difference in price isn’t much, on average: an annual rate of 5.01% on conforming and 4.9% on jumbo mortgages. However, in more expensive areas, such as California’s Bay Area, 39.5% of loans were jumbo loans in September, as a result of a median price of $815,000. The new limit of $726,525 for them still won’t reach the median with the minimum down payment of 5%, but Fannie Mae and Freddie Mac hope to take that percentage down.
Right now, it’s a gig economy for somewhere around 20% to 30% of the US workforce. Rather than having routine hours and a stable income, these workers are operating on commission and setting their own hours. Such people may be working for a company like Uber or Airbnb, or may be self-employed. While commission-based work can sometimes rake in the numbers on a good deal, sometimes you can go months or even more than a year without any income. To compound the issue, mortgage lenders are often looking for stable income — getting $1 million one day and nothing the next 6 months doesn’t enable you to qualify for a mortgage.
Two of the biggest mortgage lenders, Fannie Mae and Freddie Mac, want to change that. Fannie recently conducted a survey of 3000 lending executives, 95% of whom said current guidelines don’t count much of an increasing number of applicants’ earnings. In order to improve “access to credit,” both companies are seeking to change their guidelines to better match the gig economy. The two biggest obstacles are maintaining high quality loans and low risk of default, and automation. Freddie thinks it has a solution to the latter. A possible solution to the former is to reanalyze whether changing jobs constitutes a disruption of income. It’s entirely possible that the applicant is doing the same thing they’ve been doing for years, albeit with three different companies.
San Francisco data gives a glimpse into just how difficult it can be to own a home in California today. On a median salary of $72,340 — about $18,000 more than in other states — teachers in San Francisco are still not even able to afford 1% of the homes on the market. Some school districts are being forced to develop affordable housing for teachers to prevent loss of staff. A year of mortgage payments would cost nearly $94,800 on an average-priced home at $1.61 million.
Compare this to the year 1959, when teachers were making about $5200 per year and homes cost only $12,788 on average. Interest rates were actually higher, but payments were much easier, costing only $708 per year. Annual costs to own the average home were about 13.6% of median annual salary, compared to a whopping 131% today, nearly ten times the 1959 figure.
Why was it so much easier in the 1950s? Because it hadn’t been easy during World War II, and once the war ended, there were efforts made to fix that. There weren’t enough homes, and there wasn’t any money going into building them because of war spending. Post-war, the introduction of GI bill allowed many veterans — which were a large proportion of the population — to gain easy access to home loans, and FHA regulations also increased the number and types of loans available. With more people able to acquire loans to purchase homes, developers began building more, particularly in suburban areas.
Not everyone benefitted equally from these programs, though. FHA and VA programs both excluded African Americans and other people of color via a process known as redlining. Communities were rated on a four point scale, with red being the worst. Points were deducted from older areas and areas where people of color were living, which frequently were the same thing. This merely accelerated existing prejudices and resulted in a self-fulfilling prophecy, as already disadvantaged groups never got access to homeownership and continued to be forced to rent rather than acquire value on their home.
Interest rates are currently on the rise, and it’s difficult to get a loan below 4% interest. With some existing loans as low as 3%, more buyers may be interested in assuming a loan. Loan assumption refers to a buyer taking over some terms of an existing loan, including the rate, repayment period, and current principal balance, rather than getting a new loan. This has the primary benefit to the buyer of obtaining a lower rate on one’s mortgage.
There are some important things to know first. Not all loans are assumable. Typically, FHA loans, USDA loans, and VA loans are assumable, while conventional loans are not. These rules aren’t set in stone, so if you are interested in assuming a loan, make sure it’s assumable first. That doesn’t mean it’s a done deal, though — after making sure it’s possible, the assumptor would still need to apply for the loan and meet the lender’s requirements, and the down payment depends on the seller’s equity.
If you’re the seller, the primary benefit to having your loan assumed is that it may make your home more attractive to buyers, meaning a faster and potentially higher-priced sale. There is one drawback, though. If the lender doesn’t release you from liability as the original borrower, the assumptor not making payments or defaulting on the loan could affect your credit score.