Will Debt Limits Prevent Another Foreclosure Crisis?There has been an uproar over proposed regulations that would require a homebuyer to put down 20 percent in order to qualify for the best mortgages.  But now federal regulators have a new proposal that could limit even further who will be able to qualify for prime mortgage loans.  Federal regulators are now proposing that prime mortgage loans be limited to debtors who are paying no more than 36 percent of their income to debt. Also, debtors would only qualify for prime mortgage loans if their mortgage payment did not use more than 28 percent of their monthly take home pay.

“The debt limits are far and away the most binding constraint,” said Mark Zandi, chief economist at Moody’s Analytics. “It’s probably the one thing that will knock the largest number of borrowers out of the market by keeping them from getting the most favorable rates.”

The proposal not only affects borrowers whose total debt – including credit cards, automobile loans and student loans – is more than 36 percent of gross monthly income. It also would affect borrowers whose mortgage payment alone is more than 28 percent of their gross monthly income.

Nearly three out of every five U.S. borrowers who bought homes last year would not have met the proposed restriction on total debt, according to an analysis by mortgage research firm CoreLogic.

A separate federal analysis showed that more than half of buyers whose loans were sold to Fannie Mae and Freddie Mac in 2009 would have fallen short of one or both of the two debt requirements.

It’s possible that if these debt limits are put in place the number of people buying homes could drop significantly, or the number of buyers in subprime mortgages could rise.  But the other question is, will these restrictions go far in preventing another foreclosure crisis? Probably not. The dilemma we are currently facing is that there are an excess number of houses on the market with few buyers. The value of these homes continues to decline leaving many current homeowners vulnerable to foreclosure because they can’t even sell the homes when necessary.

By reducing the number of buyers who can qualify for a mortgage, we could inadvertently create a second wave of foreclosures which could decimate housing values.  But on the other hand, a high debt limit does increase a homeowner’s chances of defaulting and facing foreclosure.

(source: WashingtonPost.com )

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