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What Are the Ability-to-Repay and Qualified Mortgage Rules?

Effective January 10, 2014, guidelines set by the Consumer Financial Protection Bureau were implemented to help protect borrowers from taking on high-risk mortgages or mortgages they may not be able to repay. In addition, government-sponsored enterprises such as Fannie Mae and Freddie Mac decided they will not buy mortgages from lenders unless they meet the Qualified Mortgage Rule.

While all lenders are required to meet the new Ability-to-Repay Rules, lenders who keep their mortgages within their own loan portfolio are not required to comply with the Qualified Mortgage Rule.

Ability-to-Repay Rule

The Ability-to-Repay Rule is only part of what makes up a Qualified Mortgage. Under the Ability-to-Repay Rule, the lender is required to determine whether the borrower has the ability to repay the loan. The borrower will need to have proper documentation and verification of the following:

  1. Current income or assets
  2. Current employment status
  3. Credit history
  4. Monthly payment for the mortgage
  5. Monthly payments on other mortgage loans you get at the same time
  6. Monthly payments on other mortgage related expenses (such as property taxes)
  7. Other debts (such as school loans and credit cards)
  8. Monthly debt payments, including the mortgage, compared to your monthly income (“debt-to-income ratio”) or how much money you have left over each month after paying your debts (“residual income”)

Qualified Mortgage Rule

In order for the loan to be considered a Qualified Mortgage, the lender must comply with the following if they plan to sell the loan to Fannie Mae or Freddie Mac:

  1. The loan cannot have “toxic loan features” such as an interest-only period, negative amortization (when the loan principal increases over time even when monthly payments are made) or have balloon payments (when payments at the end of the loan are larger than at the beginning of the loan)
  2. Loan terms cannot exceed 30 years
  3. The loan fees cannot exceed 3% of the amount borrowed and have limits on discount points (when a borrower opts to pay a certain amount in return for a lower interest rate)
  4. The total debt-to-income ratio cannot exceed 43% of the borrower’s gross monthly income

These new rules also protect the lender from borrower lawsuits if they follow these “safe harbor” mortgage guidelines – the Qualified Mortgage Regulations.

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