Want a mortgage? Go for it! But thanks to new rules from the Consumer Financial Protection Bureau, the banks are going to need some proof first that you can actually, you know, pay it back.

Starting this week, the Consumer Financial Protection Bureau has new rules going into effect that are meant to protect homeowners from getting caught in “debt traps”: the Ability-to-Repay and Qualified Mortgage rule.

Basically, the Ability-to-Repay and Qualified Mortgage rule does what it says on the tin: lenders are now required to ascertain if borrowers stand a realistic chance of being able to repay a loan before one is issued.

If that sounds like something that should have been happening all along, your gut instinct is sound. However, part of what led to the massive meltdown of the housing market in 2008 was that many lenders stopped doing just that, instead handing out large and small mortgages to prime and sub-prime borrowers alike.

There are two parts to the rule, as the CFPB clarified in a fact sheet (PDF).  The Ability-to-Repay rule requires lenders to “look at customers’ income, assets, savings, and debt, and weigh those against the monthly payments over the long term–not just a teaser or introductory rate period.” In other words, the potential homeowner has to be able to afford the actual mortgage even if it’s going to “balloon” later, not just the first year’s worth.

The other half of the rule is the “Qualified Mortgage” part. The CFPB explains that a Qualified Mortgage:

• Cannot have excessive upfront points and fees;
• Cannot be longer than 30 years;
• Cannot have certain risky features, such as paying only interest and not principal, or paying less than the full amount of interest so that the total debt grows each month; and
• Must be in one of three categories:
  1. The monthly loan payment, plus the borrower’s other debt payments, does not exceed 43 percent of the borrower’s monthly income; or
  2. The loan qualifies for purchase or guarantee by a government sponsored enterprise (Fannie Mae or Freddie Mac), or is insured or guaranteed by a federal housing agency; or
  3. The loan is made by a small lender that keeps the loan in portfolio

Not all mortgages are required to be Qualified Mortgages, as the fact sheet makes clear.  Nor are lenders held to a firm threshold about borrowers’ debt-to-income ratios or down-payment amounts.  Banks can continue to make any type of legal loan that they feel is appropriate, provided that they feel the borrowers are qualified to repay the debt.  However, the CFPB estimates that 92% of all mortgages already fit into one of the three key categories.

The CFPB announced the new rules last January, almost exactly a year ago, and they go into effect this Friday, January 10.  The rule is a response to an order from Congress in the wake of the financial crisis.

It’s back to basics for the mortgage market in 2014 [CFPB]

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