If you are in the market for a new home, one of the many mortgage acronyms you have probably stumbled upon the last few months is QM or QRM. In some cases, it is being described as a major hurdle for new buyers and a possibly prohibitive policy for anyone looking to purchase a home. In other cases, it is being described as just another new mortgage rule that everyone will have to navigate through next year. The truth lies somewhere in between.
Of the two acronyms, the definition of QM is more important to the home buyer than QRM. A Qualified Mortgage (QM) is part of the Ability-to-Repay rule established by the Consumer Finance Protection Bureau (CFPB). Like myself you might be saying, “Well, yes, people should have to have the ability to repay a loan that they get,” and “Isn’t that what got us into this mess to begin with?” In that regard, the ability to repay certainly makes sense and, in theory, all lenders and home buyers should keep this in mind.
There are a few characteristics that make a mortgage a QM, but the biggest detail in QM has to do with the debt-to-income ratio (DTI). This calculation, in its simplest terms, is how much debt you carry broken down into minimum monthly payments, including a new home, divided by your pre-tax income. The new QM definition says that to be considered a QM, this ratio has to be 43 percent or less. At face value, this also sounds pretty reasonable. For example, before taxes, a homebuyer should be able to be at or better than 43 percent DTI, as we all know things like taxes, utilities, gas, child care and that unused gym membership add up to a healthy percentage (and are not counted in the DTI) of pre-tax income.
Of course, the devil is in the details. Here are some examples that are certainly interesting when looking at a 43 percent DTI and how it could impact a homebuyer:
1. In a “hot” real estate market (and most of Atlanta currently is with low supply and high demand), it is easier to buy first, then list/sell the current house so you do not have to move twice if you sell quickly, then take a while to find the right home. Because if the current home is not sold at the time of a purchase, both house payments would be counted in the DTI. If that extra payment puts someone over the 43 percent mark, then they technically are not QM even though their current house could sell very quickly or is currently under contract but not quite “sold.”
2. If someone is self-employed or receives 1099 income versus traditional W-2 income, then they have the ability to take advantage of certain tax laws to lower their pre-tax income base. For example, a cell phone and use of a home office are often claimed as deductions for someone not receiving W-2 income. If those deductions reduce the taxable income and make the DTI more than 43 percent, then the purchase transaction would not be considered a QM.
3. If a homebuyer would like to retain their current home as a rental property because they feel it will be a good investment over time, they are not allowed to use “rent” to offset the mortgage payment on the current home. This is because they do not have previous landlord experience or more than 30 percent equity, both of which are requirements to use new rent to offset the monthly debt. Therefore DTI reflects both the old house and the new house. Even with both mortgages and a zero rent assumption, their DTI is 44.23 percent versus the needed 43 percent, and they now are not considered QM even though they are taking an extremely conservative approach by qualifying with zero rental income.
So what happens if the loan does not meet QM requirements? Certainly there will be a market for loans that fall out of this box. Lenders and investors will realize that there are loans that are good lending decisions but do not quite fit into the QM definition. Most lending is based on risk and reward — the higher the risk, the more reward is required. Loans that fall out of the QM definition might be looked at as a higher risk, therefore the market will want higher return (in the form of interest rates or fees).
One important note is that this new rule is strictly referring to loans that do not make it through Fannie, Freddie, USDA, FHA or VA. If a loan is approved through the Government Sponsored Enterprises (GSE) online approval engines, then regardless of DTI, it is considered a QM loan (assuming it meets the other QM rules as well — DTI being the biggest hurdle). Currently, these government agencies seem to be capped in and around 45 percent DTI, so in practice, we are pretty close to QM already. The CFPB estimates that 90 percent of all current lending gets approved through the GSE’s online engines and are considered a QM. This estimation also reflects our market here in Atlanta and what we are seeing daily.
Rates are still fantastic and at historically low levels. The housing market continues to be strong in most areas. All in all, it is and should remain a great time to buy a home!
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