2013 is now behind us, and with 2014 underway, what kind of changes can we expect in home finance? The short answer: more regulatory hurdles, more due diligence by lenders, & somewhat higher interest rates & costs. What a way to start the new year! It is not all bad news though. It is important to keep perspective with regard to these changes, & there is no reason that folks should be frightened away from a home purchase. For many borrowers, the extra due diligence & regulations will be transparent, & will have minimal impact on their loan application. Over the last couple of years, borrowers have become accustomed to providing full & thorough financial documentation when applying for a mortgage loan. This practice has been in place since the financial meltdown of 2008, resulting in much higher lending standards. Up to now, lenders have been doing this to ensure the highest loan quality possible. That is simply good business in light of the recent past. For 2014, lenders will also need to ensure that a mortgage meet the standards & requirements for a “Qualified Mortgage” (QM) as set forth in the Dodd-Frank Wall Street Reform & Consumer Protection Act. Whether or not someone qualifies for a mortgage will be determined just as much by our friends in Washington as they are by a lender’s risk analysis. For this post, I will steer clear of commenting on this political hot potato. The QM requirements focus on a borrower’s “ability to repay” a mortgage loan, & the way that certain loan costs are handled. My expectation is that most lenders will be proceeding very carefully with these new QM requirements & will work hard to ensure that a loan is fully compliant. Frankly, some loan approvals obtained in the past that received the underwriter’s “benefit of the doubt” will no longer be able to be approved. Seasonal workers, some first time buyers, & those with inconsistent annual income may have additional difficulty getting their mortgages approved. There is a potential silver lining to all of this. Those that have closed on a new home in the last few years, & those that will be closing in the upcoming years will be very financially sound homeowners. This should result in a healthier real estate market & more stable homeownership. This is a very delicate balance. If lending becomes too restrictive, sellers will have to reduce prices to attract more buyers. If lending were to go back to the “old ways” of very loose credit, we risk the market “implosion” of 2008, and another round of high foreclosures.
The cost of borrowing will change for 2014. Part of this is the result of Fannie Mae & Freddie Mac (FNMA/FHLMC) increasing what is called “loan level price adjustments”. These are adjustments that lenders apply based on the perceived risk of the loan. Lower credit score? Higher cost. Purchasing a condo? Higher cost. Small down payment? Higher cost. One example has to do with how fnma/fhlmc looks at a borrower’s credit score. Currently, a homebuyer will typically get the best rates if their middle credit score is 740 or greater. In 2014, the best rates will go to those with a credit score of 780 or higher. Coupled with these adjustments, interest rates are projected to be somewhat higher in 2014 compared to 2013. As noted in a previous post, this is the result of the Federal Reserve’s decision to “taper” their purchase of debt securities. The Fed has been purchasing treasury securities & mortgage backed securities in an effort to stimulate the economy. As the economy improves, the Federal Reserve has decided that it can back off, or “taper” these purchase. This results in higher “across the board” interest rates. These should be modest, & since they are the result of an improving economy, this can be looked at as a “positive.
Keeping all of this in perspective, a homebuyer should not let these changes discourage one from a home purchase in 2014. Take note of the graph below, showing historic mortgage rates. Although rates are off of their lows from 2013, there is no question that rates are still extremely attractive, & remain at historic lows. Further, these attractive rates are on very conservative, fixed rate loans, so there is no need to turn to riskier loan products to obtain these low rates. In addition, while home values have rebounded nicely in the past year, they are still off of their highs from earlier in the decade. Finally, homeownership still provides very attractive tax benefits that are typically not realized when one is a renter.
Historic Mortgage Interest Rates:
So what steps can a homebuyer do to prepare for a home purchase in 2014?
- More than ever before, preparedness is key. Engage your mortgage lender very early on in the process. They can walk you through any additional requirements that may need to be met for the new QM compliance rules. If your income situation is unique, be prepared to write a narrative to help clarify how you earn your living. If you don’t know where certain financial documents are (such as tax returns for the last two years), start digging now. You’ll need them!
- Know your credit quality in advance. In the past, certain erroneous entries may have been “non-issues” for mortgage approval. Going forward, the cost of your mortgage will be driven even more by your credit score, so you’ll want to check early for errors. A good place to start is www.annualcreditreport.com. This site was set up by the FTC to permit all consumers to receive one free credit report per year. Although this format will not provide you with a score, it will show you the credit data that the three major bureaus are reporting, & it also provides a quick way to file a dispute if needed.
- If you have been renting, offer to your lender copies of your cancelled rent checks for the past year (assuming of course, that the rent was paid on time!). If you past rent was $1,000 per month, & your new house payment is $1,125, rent checks will go a long way to document the fact that you have the “ability to repay”. This is an old school underwriting technique that was used in the past to help supplement a credit history. Expect that this will be requested by lenders from recent renters in an effort to meet the new “QM” guidelines.
- Keep your closing schedule flexible. These guidelines are new for all in the lending industry, & there will be adjustments along the way. The industry is expecting that loan processing times will increase, but those that are well prepared will have a more manageable & predictable outcome. Stay flexible, & to the extent that you can, avoid the stress of a “drop dead” closing date.
As mentioned earlier, one should not be discouraged from making a home purchase in 2014, simply because of these changes. As always, being an educated buyer is critical. Know what your lender can and cannot do for you, make sure that clear expectations have been set. After all is said & done, you can reap the benefits of homeownership!
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