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Wednesday, July 31, 2013

Learning to Love Appendix Q - Ability to Repay Part 2

Inside the Box - It's a tight fit...

In Part 1 we talked about the benefits of Appendix Q, how having clear guidelines on how to make loans and what was acceptable for Qualified Mortgages might be a good thing.  When you dive into Appendix Q, which is the regulation that codifies those underwriting guidelines into law, you start to see the box of loans that might get approved as QMs getting smaller.  At the same time, some ambiguities still exist that a smart loan officer, processor or underwriter might use to help a borrower stretch.

Ability to Repay Cheat Sheet (QuickNotes)

This is a one page version of the 172 pages of qualified mortgage ability to repay for mortgage compliance training purposes
Download and review the cheat sheet and use it to discuss the regulations
with your staff.  Download the ABILITY TO REPAY study guide.

We have included our first draft one-pager to GoogleDocs for you to download and comment on.

Our intent is to try and take some of this massive regulation and cook it down into a manageable piece of information.  This sort of contraction works to allow us all to see the larger picture.  It does contain some shorthand for mortgage professionals, but we act in brevity in order to not waste time on flowery details.  There's plenty of time for flowery details in the CE Class.

More than anything, we want to start to look at tools we can use to work with this data  in a way that helps loan originators help customers qualify for a loan.  This is, after all, what the rule was designed to assist with.

Notable Omissions and Questions

When you review the actual text of the rule, it is clear that it has been cribbed from FHA guidelines.  They state this within the regulation, but in reviewing it clearly have failed to completely edit it, including references to "endorsement" when establishing time frames.  Obviously, this doesn't apply to the mortgage industry in general but only to direct endorsement loans.

Other references come from someone's dated recollection of the products in the mortgage marketplace.  For instance, there are multiple references to the "Two Step" loan, which Appendix Q defines as a loan with an interest rate that changes on a fixed schedule.  This was a hybrid product in the 80's, but I haven't seen a Two Step, the way it is defined within Appendix Q, since then.  The more recent definition of the Two Step was the ARM alternative to the balloon, which was fixed for 5 or 7 years, and then permanently modified to a fixed rate.  But this is not what Appendix Q refers to.

When calculating net rental income from the subject property, one area states "use the 25% vacancy factor" when another area specifies you cannot use income from a rental property when it is the subject property.

Income Quandaries in Appendix Q

The biggest trouble spot deals with variable and self-employment income, where conservative underwriting seeks to exclude any risk without defining situations that may be beneficial for the borrower.  On the pro- side, shorter than 2 years self-employment is allowed under certain circumstances.  However, Appendix Q does not specify how much a borrower's income can vary when you have declining income in an averaging scenario.  Declining income, in any situation, makes the loan ineligible.

In addition, self-employed borrowers must be compared to other similar businesses in the area.  If the other businesses are in decline the loan is ineligible.

Residual Income?  Still Not Defined

Ratios and residual income are referred to synonymously, but there is no qualification rubric for anything except for the 43% total debt ratio.  This is a hopeful sign, in that the use of a residual income computation mechanism can be applied in lieu of a ratio when circumstances dictate.  

We will examine residual income and asset depletion models in our next Appendix Q Issue - Learning to Love Appendix Q - Calculating Residual Income Methods

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