Perhaps you are looking to purchase your first home, or perhaps you need to refinance. Getting a loan involves contacting a lender and providing them with information about your assets, income and expenses. For new and existing borrowers this can be confusing and frustrating. People who pay more in monthly rents may be told they cannot afford a monthly mortgage. New regulations from the Consumer Financial Protection Bureau are designed to provide more transparency, and to help borrowers understand what will be required for them to qualify for a home mortgage.

Beginning in January 2014, lenders are required to document a borrower’s ability to repay a home mortgage loan. Specifically, lenders may not enter into home mortgages unless the total of all of a borrower’s monthly debt payments are less than 43% of their monthly income from all sources. Income includes salaries, self-employment income, investment income, and all other sources of income. Applicants may be requested to provide up to three years of tax returns and other documents supporting their income. Lenders, especially those looking to resell their loans, will require strict compliance with these new guidelines. Many lenders may even cap the debt to income ratio below the 43%. In more conservative times, lenders would not approve mortgages where the monthly payment was greater than 25% of monthly gross income, and total debt payments were greater than 33% of total gross income. As the cost of money to banks fell, and government assurances increased, banks became more aggressive in making loans to buyers. Even under the new more restrictive rules, borrowers with substantial debt obligations can still obtain home loans.

Under the new guidelines lenders must make a "good faith" and "reasonable" effort to make sure a borrower has the ability to repay their mortgage. This “ability-to-repay” rule requires lenders to conduct more due diligence in assessing a borrower’s ability to repay. To be a "qualified mortgage"  loans are required to meet three minimum guidelines:

• Points are limited to a maximum of 3% in most cases
• Loans may contain no risky provisions
• Loans may not exceed a 30 year term

Undoubtedly, fewer borrowers will be able to qualify for mortgages. Borrowers who spend one-half or more of their monthly income on debt payments and have no savings will find it difficult to obtain financing. For example, an individual that seeks to make monthly mortgage payments of $2,000 on a salary of $5,500 per month would be rendered ineligible for a QM loan with even a relatively modest amount of credit card debt of, for example, $500 monthly payments. That’s because a total of $2,500 in debt payments per month is more than 43% of the borrower’s total monthly income. This restriction will make it particularly difficult for those with student loans to also purchase a home. Some lenders, especially local savings banks, who do not resell their loans, may be more flexible.

The new rules seek to foster healthier debt-to-income ratios. Ideal ratios are probably closer to 33% or less as opposed to the 43% ceiling that the CFPB has decided upon. Lower ratios will leave room for borrowers to save more of what they earn or contribute more to a retirement plan. While this choice is up to you; having a financial cushion is always a wise financial approach.