One of the after-effects of the recent financial crisis is the passage of the Dodd-Frank Mortgage Reform. Once the changes come into effect in January of 2014, it might be harder for you to qualify for a mortgage.
What's the reason for the reform, you wonder?
Well, some financial services companies were underwriting loans and then selling them to lenders. Because they were getting very lucrative upfront fees for originating these loans, some of these companies gave loans to people that couldn't be reasonably expected to pay them back.
So, the Dodd-Frank Act was passed in 2010 to try and stop this kind of predatory lending practice, according to Mitchell D. Weiss, an experienced financial services industry executive, author, and adjunct professor of finance at the University of Hartford. And now, the act is being reformed to protect consumers even further.
Let's take a closer look at eight factors you'll need to consider to qualify for a loan once the reform goes into effect in January.
You'll need enough income or assets to cover your mortgage payments.
It's probably pretty obvious why your income is something important for lenders to look at when determining how much you can afford to borrow - and it's something lenders have been taking into consideration for a long, long time.
"If you go back to the beginning of mortgage lending, you had what we call the 'Four Cs' of traditional lending: capacity, cash, credit, and collateral," explains Hollensteiner.
"The Dodd-Frank Act is very much a literal explanation of those. So when we talk about the borrower's ability to repay the obligation, it's all about the borrower's capacity," Hollensteiner says. By capacity, he's referring to the borrower's income or assets and whether it's sufficient enough to make the monthly mortgage payments.
You'll have to prove employment - or income from self-employment.
One of the surest ways to guarantee income is to have a job. So, this is another pretty obvious thing for responsible lenders to ask potential borrowers about.
"This is as important today as it has always been," Hollensteiner says. "Do you have a position that will be here tomorrow? We can't predict the future, but if a lender finds out a borrower's job will expire prior to the loan closing, that might cause the lender to reconsider the borrower's profile." Without another job lined up, a lender could worry you might not be able to pay the mortgage.
Where this gets a bit trickier is when it comes to self-employed borrowers. If you're an independent contractor, your jobs might only last a few weeks or months - and that could make it hard to convince lenders you're a safe bet.
"Self-employed borrowers have to show a two-year track record of having been in the same business, along with two years of federal tax statements to show their income," Hollensteiner says.
If you're self-employed and thinking about applying for a mortgage, it might benefit you to talk to a mortgage professional to find out what you'll need to prove your income.
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You'll need to prove you can afford property tax and homeowner's insurance.
In addition to principal and interest payments on your mortgage, you'll also have to pay property taxes, homeowner's insurance, and possibly additional fees like a homeowner's association (HOA) fee. The Dodd-Frank Act wants all of those taxes and fees to be clear to borrowers up front.
"Lenders need to document every payment associated with the property and what it entails," says Hollensteiner. "It's important for the consumer to know what the total payments are for the property."
You'll have to factor in the amount you pay on any additional mortgages.
This factor applies to homeowners who might take out more than one loan on their home, like a second mortgage or a "piggyback loan."
The Dodd-Frank Act simply requires lenders to include both payments (for the first and second mortgage, in this example) when they're figuring out whether or not a borrower is qualified for a loan.
Believe it or not, some lenders previously weren't including the payment on the second mortgage in their calculations - even though it's money the borrower will be expected to pay every month.
You'll need to provide full disclosure of any additional properties you own.
Do you own a second home somewhere? If so, all mortgage-related costs for all of your properties should be included in a lender's calculations to determine if you qualify for a new mortgage under the new reform.
"This would pertain to any properties the borrower owns. Investment properties, second homes, vacation homes, etc," says Hollensteiner. "The lender needs to have full disclosure to the total monthly obligations on all the borrower's other properties."
If you pay child support, you'll have to calculate that in, too.
Maybe you don't have a second property, but you do have to pay alimony or child support every month.
That will also be taken into consideration, as lenders will be required by law to include things like alimony and child support in their calculations. Although the Federal Housing Administration takes this factor into consideration already, it may not be common practice across all lenders.
"The borrower might qualify based on income and debts alone, but monthly alimony payments could have a major impact on their being able to pay," says Hollensteiner. "If the lender doesn't include those obligations, the lender could be helping the borrower get financing that he or she won't be able to continue paying down the road."
You'll need a debt-to-income ratio that's lower than 38 percent.
One of the major tools lenders use to determine whether a borrower qualifies for a new loan is the debt-to-income (or DTI) ratio.
"The monthly debt-to-income ratio calculations have been in the lending industry for - probably forever," says Hollensteiner. "What we're seeing today in the industry is that the maximum DTI range is 38 to 41 percent of the borrower's gross monthly income." That's the highest DTI lenders typically consider when determining whether or not to qualify someone for a mortgage, Hollensteiner explains.
To calculate your DTI ratio as a percentage (which is how lenders typically consider DTI ratios), divide your monthly debt repayments by your gross monthly income (before taxes), and multiply that number by 100. But why is the DTI ratio so important?
"It validates you've got a loan that meets the definitions of a safe loan," says Hollensteiner.
You'll need a clean credit history, and a good credit score.
You probably know that your FICO credit score can be used for everything from determining what interest rate you'll pay on your credit cards, to whether or not you qualify for financing on that new car loan. It should come as no surprise, then, that it's important to lenders, too.
"Going back to the 'Four Cs' of traditional lending, credit has always been considered," Hollensteiner says. "It is tremendously important, and it is a great indicator of how likely the borrower is to repay the obligation."
So it might be worth getting a hold of your credit report and doing whatever you can to improve your score. Pay your bills on time, every time. Dispute any errors on your report. A little effort now could pay dividends down the road when it's time to apply for your mortgage, that's how important your credit history is.
As Hollensteiner notes, "even in the dark ages of business, every lender - even if they didn't look at anything else - looked at credit report."
