Beware the QRM

Under the auspices of the Consumer Financial Protection Bureau (CFPB), which sprung from the Dodd-Frank financial reforms, the US Treasury is readying its rules for what is referred to as a Qualified Residential Mortgage (QRM). While the rules are not yet final the advance information indicates there are at least a few things that are of particular interest to anyone hoping to purchase a home with a new loan or refinance an existing one. Boomers in particular will likely be impacted by a number of the proposed restrictions having to do with debt ratios, acceptable methods of documenting income and downpayment/equity. The changes have the potential to put the recovering housing market right back on its ear if they are all enacted as proposed as a large number of potential home buyers will no longer be able to qualify at the level they can today. While the new rules will not fully go into effect until January, 2014 you can bet that lenders will begin to layer the changes into their requirements as soon as they are convinced of the final regulations.

Because almost every loan (save for those made by “private” lenders) will need to conform to the new guidelines, the argument can be made that once again, the rules will serve to protect lenders from themselves while negatively impacting access to home mortgages. Consider that the proposal suggests that no loan can be considered where the overall debt ratio of the borrower exceeds 43% of their calculated gross monthly income – regardless of equity or liquid assets. While the argument can be made that 43% might be an appropriate number for most families, consider that conventional loans are currently approvable with debt ratios as high as 50% and we have seen recent FHA approvals as high as 57% if the loans are approved through a rules based, automated underwriting system. The impact in high-cost housing areas will be staggering when you consider that a 14% reduction in the maximum debt ratio effectively eliminates over 25% of the pool of eligible borrowers that heretofore would have qualified for the financing to purchase a particular home.

Consider, also, that many retired folks live off a combination of social security, income from retirement accounts and savings. To the extent that a borrower uses savings that are in non-retirement accounts to supplement social security, the withdrawal of those funds is not considered income and thus, cannot be considered in calculating the 43% maximum debt ratio under the CFPB rules as currently enacted. From the perspective of a borrower that is interested in mitigating tax liability and is able to draw upon non-taxable savings in deference to taxable withdrawals from IRA or 401K accounts the consequences can be staggering. We have already seen this manifest itself with borrowers that were fully able to purchase their retirement home and qualify for their loan of choice before the previous changes that came to the market in 2010 regarding the prescribed method for income documentation. Now, many of those existing homeowners can no longer qualify to refinance their current mortgages because the use of non-taxable savings for daily living expenses is no longer considered when calculating debt ratios and incomes (regardless of the balances in those accounts or the fact that they have been making the payments previously as agreed) – only funds withdrawn from taxable accounts can be counted. Layering into that reality those newly recommended debt ratios are set to be crunched down to a level that requires more and more income to qualify which can only mean higher and higher tax bills for the borrowers as they rearrange their finances to make themselves more credit-worthy in the eyes of the CFPB. The only alternative is to live with their current financing, which many times is at nearly twice the current interest rates or retire the debt with liquid assets, if available, which very well may trigger a whole new set of tax consequences.

I’ll do my best to try to keep you informed as the rules wind their way through the various governmental agencies. If you own a home and it’s not “free and clear” this is important stuff to understand.