The ability to repay a loan is a little like the Bing Crosby – Irving Berlin favorite “White Christmas.” Musical fads come and go. Yet every year we come to December and “White Christmas” returns.  It’s timeless.

Shortly after Christmas, on January 10, 2014, those looking to buy a house will find the new federal Ability-to-Repay rule still wrapped waiting for them under the tree.  Next to the Ability-to-Repay rule will sit the broader, more powerful federal lending standard known as the Quality Mortgage (QM) standard.  These sugar plums dancing in heads of future homebuyers were designed by the Consumer Protection Financial Bureau to protect consumers against some of the most dangerous mortgage excesses and help Christmases of the future remain a timeless moment enjoyed by friends and families without fear of an impending repeat market crash.

The Ability to Repay – Keeping off the Holiday Debt

Underneath the paper and bow, the ability-to-repay rule gives the gift of financial safety. The idea is to force lenders to finance loans that the consumers can afford. In the past, dangerous lenders could put a bow on an expensive home and left it for the person whose total income and assets amounted to a few lumps of coal. With this new Ability-to-Repay rule, the amount of home purchased will have to match closely to the customer’s actual financial picture.

During the loan application process with a loan officer and underwriting crew, lenders will examine a set of financial documents (W2 paystubs, etc.) and see if the applicant can repay the loan, based on:

• Current income or assets
• Current employment status
• Credit history
• Monthly mortgage payment
• Monthly mortgage payments on any other properties
• Monthly payments for other mortgage-related expenses (property taxes, etc.)
• Debt-to-income ratio (measuring monthly debt vs. monthly income)
• Available money for other monthly expenses

The Ability to Repay and QM

The Ability-to-Repay rule is just one reindeer now leading the sleigh of the home mortgage industry. The new QM standard is a set of guidelines for each new loan that takes into account the ability to repay.  It also rules out certain predatory lending practices.  For example, if a home loan does not meet the QM standard, the borrowers will have a better case in any legal action against the lender.  Likewise staying within the QM and the Ability-to-Repay guidelines will provide mortgage lenders certain protections in case of lawsuit.

In addition, Fannie Mae and Freddie Mac, the nation’s leading purchasers of mortgage notes on the secondary market, have stated they will not purchase loans outside of the QM standard.  That’s crucial.  Mortgage lenders count on Fannie and Freddie purchases to supply the money (liquidity) to pay for many homes.  Limiting these secondary investors will strongly encourage QM lending, and thereby make lending safer for everyone.

A QM loan includes the following elements:

• A full documentation loan (all income and assets documented)
• Sufficient borrower assets and income
• Maximum debt-to-income ratio of 43 percent

A QM loan must not have:

• Excessive upfront points and fees
• A term over 30 years
• Interest-only (payments equaling the interest, leaving the principal unchanged)
• Negative amortization (payments less than interest, adding to the principal)
• Balloon payments from most lenders (single large payment at the end of the term)

The Ability-to-Repay rule and the QM standard are ways that mortgage lenders will give you the gift of financial security shortly after the holidays and into the New Year. The Ability-to-Repay rule will hopefully help new homeowners keep off the extra weight of unmanageable and unqualified debt in 2014