In recent years, homeowners have been encouraged to take advantage of historically low interest rates to refinance their mortgages. While many immediately jumped on the opportunity, others decided to wait until they were in a stronger financial position or until they felt the housing market had stabilized.
Homeowners who waited until 2014 to refinance their homes are encountering a new set of lending criteria that may prevent them from securing the loan. In January, the Consumer Financial Protection Bureau (CFPB) introduced a new loan category called the qualified mortgage. From a consumer standpoint, qualified mortgages boil down to one basic premise: the lender must make a good-faith effort to determine that the borrower has the ability to repay the loan.
On the surface, it seems absurd that lenders would even consider lending to a borrower who does not have an adequate job history, income stream or assets to repay a mortgage loan. However, lenders making large loans to borrowers who could not demonstrate their ability to repay was among the root causes of the mortgage meltdown.
The CFPB determines a borrower’s ability to repay a loan based on his or her debt-to-income ratio. In simpler terms, lenders are taking a closer look at how much debt service a borrower already has in comparison to the amount of income coming in on a regular basis. If the ratio exceeds 43 percent, the borrower is not eligible for a qualified mortgage loan.
Now that the qualified mortgage rules are in full effect, most mortgage brokers are tightening their data collection and verification processes to ensure that all mortgage applications are properly qualified. Many financial institutions aren’t willing to work with borrowers whose debt-to-income ratio exceeds 43 percent because the CFPB offers lenders certain liability protections for qualified mortgage loans. Specifically, borrowers cannot seek legal action against lenders for making a loan that meets the qualified mortgage criteria. Why should lenders risk being sued by a borrower for making a “risky” loan when they are protected for making loans perceived by the government to be “safe?”
Mortgage bankers and realtors anticipate this rule may have a severe impact on the industry. According to the National Association of Realtors, 55 percent of the mortgage brokers surveyed estimate that the qualified mortgage rule will affect up to 20 percent of their loan originations.
Based on a forecast by the Mortgage Bankers Association (MBA), a midpoint of affected loan originations could be approximately $135.6 billion. With an MBA estimated average mortgage size of $289,650 in 2013, it is possible that 469,000 borrowers in the U.S. will be directly affected by the qualified mortgage rule in 2014.
One of the factors preventing many borrowers from meeting the debt-to-income ratio is high-interest credit card debt. By the middle of 2013, Americans carried in excess of $850 billion in credit card debt at an average annual interest rate of 15 percent.
It’s easy for most of us to sit back and say that individuals with excessive credit card debt should not receive the same favorable rates or refinance opportunities as those with better credit scores and less debt. The perception is that these people are spendthrifts who deserve to face the financial consequences. However, this perception could not be farther from the truth.
According to a study by CreditCards.com, much of our nation’s credit card debt was accumulated as families used them to pay for the basics during difficult times:
- 86 percent of low and middle-income households who experienced financial hardship from 2009 -2012 due to unemployment and used credit cards to pay for basic expenses.
- Nearly half of low middle-income households carried debt from out-of-pocket medical expenses in 2012.
- 60 percent of low and middle-income households incurred credit card debt to help a child pay for college expenses.
- 71 percent of low and middle-income households say that college expenses are a factor in their accumulation of personal credit card debt.
With traditional lending institutions no longer willing to refinance homeowners with large amounts of credit card debt, what options remain available? Not many.
Some lending institutions are creating new mortgage and refinance products targeted specifically for homeowners who cannot receive a qualified mortgage. Unfortunately, these products come with high interest rates.
Another strategy is for the homeowners to restructure their finances to become compliant. One way to do this is through a signature loan or line of credit from a traditional lending institution, such as a bank or credit union, to pay down the debt before applying to refinance a mortgage loan. While this might make sense for long-term debt consolidation or reduction, lenders are likely to turn down this loan application for the same reasons they turn down the homeowner’s application to refinance. If the lender does offer a loan, it will be at such a high interest rate that the borrower will not likely be able to reduce the debt-to-income ratio enough to qualify for the refinancing.
CreditCircle, a lending company, is leveraging its Sponsored Loan concept to help homeowners reduce debt in order to refinance with a loan product called the MQA loan. There are two steps to the MQA loan process. First, the borrower enlists a Sponsor to back a three-to-five-year loan that will consolidate and pay off existing high-interest debt. Sponsors can be anyone the borrower knows, including parents, siblings, relatives, friends or coworkers. By having a sponsor guarantee the loan, the borrower can receive a lower interest rate.
Second, with the MQA loan is in place, the borrower may qualify to refinance the mortgage and free any equity built up in the house. This equity may be used to pay off the MQA loan early; typically within only a few months of securing it. At the end of the process, the homeowner has not only refinanced the home, but has also relieved himself or herself of burdensome, high-interest debt.
Consider this real world example of the MQA loan in action. “Kim” applied with a local lender for a debt consolidation refinance. Her debt obligations were $1,012 per month, causing her to have a 47 percent debt-to-income ratio, and her FICO score was 597. With these figures, Kim was not eligible for a qualified mortgage loan. She secured a Sponsor for a $25,000 MQA loan at an interest rate of 12.53 percent (based on her Sponsor’s FICO score of 754), which reduced her monthly payment to $574.09 and dropped her debt-to-income ratio to 27 percent.
Additionally, Kim’s recomputed FICO score increased to 620. Kim now is now eligible for a qualified mortgage loan and is able to use cash from refinancing her mortgage to completely pay off the MQA loan.
The qualified mortgage ability-to-repay rule does not have to be a hindrance to homeowners who want to refinance their home mortgages. By looking at all the available options and working with the right partner to reduce credit card debt, it is possible to refinance a mortgage and get a lower interest rate regardless of a high debt-to-income ratio.
David Shimko is a co-founder and CEO of CreditCircle, a lending company. For more information about CreditCircle and its Sponsored Loans, please visit www.creditcircle.com.