The media has been having a field day touting the subprime mortgage crisis and how the effects are starting to spread. Up to this point, the fallout has been limited to a) a dramatic reduction in the ability of low credit folks to borrow money against a home, b) large amounts of money lost by private investors in subprime mortgage bonds, and c) slightly increased rates on anything but traditional prime mortgages. For example, jumbo mortgage rates are a few eighths higher than they have been for the past few months. While these changes will affect millions of low credit homeowners and would-be homeowners, most Americans have been insulated from the crisis. However, the mortgage industry is taking another dramatic step towards tightening up the supply of credit.

Please note that these changes are not all final and most have yet to be ‘officially’ announced, here are some things to expect over the next two weeks:

1) Lenders will no longer fund cash-out refinances (typically used for debt consolidation or home improvements) for greater than 70% of a home’s value. Rate and term refinances (where the amount of debt does not increase other than to cover closing costs) may be exempt from these changes.

2) Investors buying or refinancing rental properties may be required to have 30% equity in the property. That means 30% down payments for rental properties.

3) Loan applicants will have to qualify for loans based on fully indexed and fully amortized payments. Consider buying a $20,000 home with a $40,000 down payment. Your loan will be for $120,000. Annual taxes are $3000 and insurance costs $100 per year. The full monthly payment (PITI - Principle, Interest, Taxes, and Insurance) on a traditional 30 year fixed mortgage at 6.375% would be $1,348.19 per month. Assuming you have no other debt, you need to show income of about $36,000 per year in order to qualify for this loan.

What if you just got out of school and are working at an entry level position for $32,000 per year but still wish to buy that house? Used to be that you could use an adjustable-rate, interest only loan. The rate would be lower (because you assume the risk of rate fluctuations rather than the lender) and you only pay interest. So you save doubly - no principal and less interest. Your equity buildup will be slower, but many people used to think that housing never declined in value, so that wasn’t a problem.

So on a 5-1 interest-only LIBOR ARM, your monthly PITI payments would be only $1,183 for the first five years. You would only need about $32,000 in income to qualify. Voila! The house is yours. Five years down the road, however, you hope to have refinanced or sold the home, because otherwise your payments would begin to spiral upwards (assuming today’s rates) AND you would begin to pay principle, so your payments would jump to $1,532 per month. Soon however, you will have to qualify for the loan from day one based on that higher payment amount.

4) Last, but absolutely not least, stated income loans are gone. That’s right, no more stated income. You will have to fully document every penny of income for qualification purposes. If you are earning income under the table, you will not be able to use that income to qualify. Likewise, if you are self-employed for less than two years, kiss home ownership goodbye, at least until your two year anniversary.

The bottom line from these changes is that people will no longer be able to buy more home than they can currently afford on the hope that their income will increase, or continue to use home equity accessed through cash-out refinances to fund their standard of living. As a young American, the best thing you can do to prepare for these changes is to groom your credit report (no late payments or high credit card balances!), save towards at least a 5% down payment, and be prepared to document at least 2 years of solid income history before trying to qualify for a mortgage. If you already own a home, make sure that you have adequate emergency savings and that you will be able to afford your higher mortgage payments down the road if you are on an adjustable or interest-only mortgage.