The Dodd-Frank mortgage shift: From pre-qualify to pre-approval
The Dodd-Frank Consumer Protection Act, which was signed into law in July 2010, forever changed the housing market landscape. Designed to restore consumer confidence in the housing industry, the law has created strict regulatory mandates, the impact of which are being felt by both mortgage lenders and mortgage seekers.
Potential homebuyers are unlikely to be aware of these nuances, and that's fine, but loan officers could use a few strategies to help them walk their clients through the pre-approval process.
One specific area where the changes are being felt is in the pre-approval process. Previously, at the start of the homebuying process, it was customary to obtain a pre-qualification, which essentially meant that a buyer “could” qualify if they found a home, but it wasn’t a guarantee. These new regulations are making sellers leery of pre-qualifications and are causing them to demand pre-approvals, an actual credit approval decision, instead.
Pre-approval actually has a positive outcome for some buyers. With the speed at which homes are now moving, buyers with a pre-approval attached to their bid are more likely to be considered than those without one. The pre-approved buyer is the next best option to an “all cash” buyer who requires no financing at all.
So what all goes into the pre-approval process?
The pre-approval process involves efforts of the homebuyer to complete an application and provide verification documents for income, assets, employment history and credit. Make sure they know that more time is necessary to improve their chances.
One strategy is to let the potential homebuyer know the loan officer must obtain all documentation before an Underwriter will even be able to look at the pre-approval request.
In the face of the Dodd-Frank mortgage environment with rules unfamiliar to homebuyers – like the Ability To Repay rule (called QM) and the Qualified Residential Mortgage rule — the following items are now required by an Underwriter to prove before issuing a pre-approval:
- A buyer’s ability to repay the loan by reviewing current income verification items and historical income from two years of consistent past employment
- Verification of the cash needed to close by reviewing the source of the down payment, closing costs and cash reserves after closing
- Evaluation of the buyer’s credit history with specific attention to the middle credit score, any derogatory accounts like collections and disputed account, and any public records related to foreclosure, bankruptcy and judgments
The self-employed will also have an additional challenge, as they will be tasked with proving qualifying income and projected income sustainability.
This analysis of income is based on the last two years of personal (and business) tax returns, so less than two years of self-employment with positive income is nearly an immediate disqualifier. This will impact the effectiveness for the self-employed to take as many deductions and write-offs on their taxes. Many tax mitigation benefits may negatively affect the self-employed homebuyer’s ability to qualify for a new mortgage.
It is never too early to begin the pre-approval process for homeowners, as much like health concerns, early detection is the key.
[Ed Note: Jeannie Smith, Loan Officer for Guardian Mortgage, is fielding questions from clients on the potential impact of the Dodd-Frank Consumer Protection Act on the home purchase and refinancing process — which begat this blog post. Her opinions expressed above are her own.]