New Rule Means Banks Will Have To Make Sure Borrowers Can Actually Repay Mortgages

When the housing market collapsed five years ago, it was due in no small part to mortgage lenders who handed out loans without really considering whether or not the borrower could ultimately pay that money back. Hoping to minimize the chances of this happening again, regulators have introduced a new rule today.

The rule, announced by the Consumer Financial Protection Bureau and mandated by the 2010 Dodd-Frank financial reform overhaul, essentially requires mortgage lenders to ensure that prospective buyers have the ability to repay their mortgages.

Three important facets of the new rule, which will go into effect next January:
Financial information has to be supplied and verified: The lender is required to review the following from each borrower — employment status; income and assets; current debt obligations; credit history; monthly payments on the mortgage; monthly payments on any other mortgages on the same property; and monthly payments for mortgage-related obligations.

This means the end of so-called “no-doc” or “low-doc” loans, in which lenders handed out mortgages without reviewing (or with minimal review of) the borrower’s financial information.

A borrower has to have sufficient assets or income to pay back the loan: In addition to reviewing the above financial info, lenders need to look at things like the borrower’s debt-to-income ratio to determine whether that applicant actually has the ability to take on — and repay — the additional debt of a mortgage loan.

Teaser rates can no longer mask the true cost of a mortgage: For loans with interest rates that increase or vary over time, the lender can no longer make an ability-to-repay decision based solely on the lower, introductory rate. Lenders will have to determine the consumer’s ability to repay both the principal and the interest over the long term.

Under the new rule, here is what the CFPB describes as a “Qualified Mortgage”:

No excess upfront points and fees: This is intended to keep borrowers from being hit with an excess of costs at the front-end of the loan for points and fees, including those used to compensate loan originators, such as loan officers and brokers.

No toxic loan features: Under the new rules, mortgages with terms that exceed 30 years, or have interest-only payments, or feature negative-amortization payments where the principal amount increases, will not be deemed as Qualified.

Cap on how much income can go toward debt: In general, a Qualified Mortgage will be provided to people who have debt-to-income ratios less than or equal to 43%. There will be a transitional period during which loans that do not have a 43% debt-to-income ratio but which meet government affordability or other standards — like being eligible for purchase by the Fannie Mae or Freddie Mac − will be considered Qualified Mortgages.

“When consumers sit down at the closing table, they shouldn’t be set up to fail with mortgages they can’t afford,” said CFPB Director Richard Cordray. “Our Ability-to-Repay rule protects borrowers from the kinds of risky lending practices that resulted in so many families losing their homes. This common-sense rule ensures responsible borrowers get responsible loans.”

The folks at the Center for Responsible Lending offer cautious praise for the new rule, saying it does address head-on a key cause of the mortgage meltdown and ensuing recession: Lenders who made high-risk, often deceptively packaged home loans without assessing if borrowers could repay them.

However, in a statement, CRL President Mike Calhoun states that the new rule leaves one major issue unresolved: How fees that lenders pay to mortgage brokers will be counted when it comes to defining a qualified mortgage.

“These fees, known as yield spread premiums, provided incentives for brokers to steer borrowers into bad mortgages that fueled the mortgage crisis,” explains Calhoun. “The CFPB should not create a loophole that allows high-fee loans to count as a qualified mortgage under Dodd-Frank. This must be addressed.”

Meanwhile, the Wall Street Journal website has this helpful FAQ regarding the impact of the new rule.