A long-awaited rule that will require mortgage lenders to ensure that borrowers have the ability to repay their loans is getting mixed reviews from industry and consumer groups.
Aimed at protecting borrowers from risky and deceptive lending practices that contributed to the housing boom and bust, the ability-to-repay rule announced today by the Consumer Financial Protection Bureau will take effect Jan. 10, 2014.
The CFPB was charged with drafting and implementing the rule under the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act. The announcement detailing the rule’s provisions has groups that represent the mortgage industry worried that the rule could further restrict an already tight lending environment.
Lender groups praised a "safe harbor" policy that will provide some protection from lawsuits when borrowers take out lower-priced prime "qualified mortgages" intended for borrowers who are considered low risk.
Government-backed loans — including those eligible for purchase or guarantee by Fannie Mae and Freddie Mac — will temporarily be considered qualified mortgages even when borrower’s debt-to-income ratios exceed the 43 percent debt-to-income limit set by the rule.
A consumer group, the Center for Responsible Lending, praised what it called the bureau’s balanced approach, although the group said it would have preferred that the rule allow any borrower to sue lenders who fail to evaluate their ability to repay.
Under the new rule, lenders will have to determine whether the borrower has the financial means to pay both the principal and interest on any new mortgage over the long term. Lenders will not be allowed to consider only introductory "teaser" rates in this calculation.
"No doc" and "low doc" loans will be prohibited. During the housing boom, lenders often made such loans without worrying about the borrower’s ability to repay, because the loans were bundled into securities that were sold to investors.
Easy access to credit fueled an unsustainable increase in home prices that led to a wave of delinquencies and foreclosures that precipitated a financial crisis the nation is still recovering from.
Since September 2008, about 4 million borrowers have lost their homes to foreclosure, according to data aggregator CoreLogic.
"When consumers sit down at the closing table, they shouldn’t be set up to fail with mortgages they can’t afford," said Richard Cordray, the bureau’s director, in a statement.
"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."
In order to determine a borrower’s ability to repay, lenders must consider and verify eight underwriting criteria:
- current employment status;
- current income and assets;
- current debt obligations;
- credit history;
- monthly payments on the mortgage;
- monthly payments on any other mortgages on the same property;
- monthly payments for other mortgage-related obligations, such as property taxes; and,
- the monthly debt-to-income ratio or residual income the borrower would be taking on with the mortgage.
If a lender issues a "qualified mortgage," it will be presumed to have complied with the ability-to-repay rule, the CFPB said.
A qualified mortgage prohibits excessive points and fees (generally, those above 3 percent of the loan amount) tacked on to upfront origination costs; cannot have risky loan features such as a term that exceeds 30 years, interest-only payments that don’t pay down a mortgage’s principal, or negative amortization payments where the principal amount increases; cannot have a balloon payment at the end of the loan term except, under certain circumstances, those made by smaller creditors in rural or underserved areas; and, the borrower’s debt-to-income ratio — his or her total monthly debt divided by total monthly gross income — cannot exceed 43 percent.
Temporary exemption for government-backed loans
For now, loans with debt-to-income ratios above 43 percent will be considered qualified mortgages so long as they meet underwriting requirements of government-sponsored enterprises Fannie Mae or Freddie Mac, or the U.S. Department of Housing and Urban Development (HUD); the Department of Veterans Affairs (VA); or the Department of Agriculture (USDA) or Rural Housing Service.
The bureau issued the temporary exemption for government-backed loans out of concern "that creditors may initially be reluctant to make loans that are not qualified mortgages, even though they are responsibly underwritten," the CFPB said in a summary of the rule.
"This temporary provision will phase out over time as the various federal agencies issue their own qualified mortgage rules and if GSE conservatorship ends, and in any event after seven years," the bureau said.
There are two types of qualified mortgages that offer differing legal consequences for lenders. Higher-priced loans, generally given to borrowers with an insufficient or weak credit history, will have a "rebuttable presumption," meaning that, legally, lenders are presumed to have vetted the borrower’s ability to repay the loan, but that the borrower can challenge that presumption in court.
Lower-priced, prime loans, given to borrowers considered less risky, will have a "safe harbor" status. Borrowers may sue their lender only if they believe the loan does not meet the definition of a qualified mortgage.
The rule does not affect the rights of a consumer to challenge a lender for violating any other federal consumer protection laws, the CFPB said.
The agency also released proposed amendments to the ability-to-repay rule today.
The proposed amendments would make exceptions for certain nonprofit creditors that work with low- and moderate-income consumers and for certain homeownership stabilization programs that help homeowners avoid foreclosure. They would also deem certain portfolio loans made by small creditors, such as community banks and credit unions, as qualified mortgages.
The proposed amendments also ask for public comment on how to calculate loan origination compensation under the qualified mortgage rule’s point and fees provision.
Reaction from industry, consumer groups
Debra W. Still, chairman of the Mortgage Bankers Association (MBA) commended the CFPB for the "deliberative and inclusive process" used to create a rule that "may be the single most impactful rule that will affect mortgage lending in this country coming out of the Dodd-Frank law."
"(W)e applaud the bureau for offering a legal safe harbor to lenders when they originate loans that meet the rigorous ‘qualified mortgage’ standards in the rule. This approach should allow lenders to offer sustainable mortgage credit to a great number of qualified borrowers without having to risk unreasonable and overly punitive litigation and penalties," Still said in a statement.
She cautioned, however, that "credit is tighter than at any point we can remember," and that certain parts of the rule could curb competition, increase costs and further tighten credit availability for borrowers.
"In particular, the 3 percent cap on points and fees appears to be overly inclusive as it relates to compensation and affiliates. Loans with the same interest rate, terms and out-of-pocket costs should be treated the same under the rule regardless of the organizational structure or business model of the lender," Still said.
"Additionally, we will be looking carefully at whether the interest rate threshold for the safe harbor, which is set at 150 basis points above the benchmark rate, will adversely impact too many borrowers. These pricing-related restrictions need to be carefully examined to ensure that they do not unnecessarily restrict consumer access to ‘qualified mortgages,’ including smaller-balance loans, as well as jumbo loans."
Ultimately, she said, the market will give the final verdict on the rule.
"We believe the rule will effectively block the return of risky product features and inadequate documentation. If it also provides lenders the certainty needed to originate qualified mortgages broadly across the market to creditworthy borrowers, it will have been a success," Still said.
"However, if the result is a tightening of credit as lenders pull back from offering loans that would create greater risk of litigation, the CFPB may need to quickly revisit the rule to avoid harming the housing recovery."
Barry Rutenberg, chairman of the National Association of Home Builders (NAHB), said it was essential that the rule strike a balance that will encourage lenders to provide creditworthy borrowers access to affordable home loans, and assure them that they will be protected from lawsuits if they meet the rule’s criteria.
"Our initial review of the QM rule indicates that this balanced approach can be achieved. NAHB is encouraged that regulators heeded concerns from the housing industry to craft a broad standard that includes many of today’s sound mortgage products, including fixed-rate and adjustable-rate mortgages, under the QM standard," he said in a statement.
Frank Keating, president and CEO of the American Bankers Association, said the rule ensures most consumers will continue to have access to safe credit, but that its complexity presents an additional regulatory burden on lenders.
"Qualified mortgage, as defined by the rule, imposes strict lending standards. While QM encompasses many of the loans being underwritten today, it must also interact with a number of other mortgage rules that CFPB will be issuing this month. There is a very real impact to these rules, and they will transform our lending practices and could restrict access to credit," he said in a statement.
"We commend the bureau for recognizing the need for a safe harbor to prevent a reduction in credit availability and unwarranted lawsuits that ultimately drive up the cost of loans for consumers."
The Center for Responsible Lending, a nonpartisan consumer advocacy group, praised the CFPB’s balanced approach to mortgage lending and consumer protections.
"The standard CFPB establishes for a safe, well-underwritten mortgage is appropriately broad enough to include the vast majority of creditworthy homeowners, and it is clear enough for lenders and borrowers alike to understand. And the rules preserve legal protection for borrowers with the riskiest loans," the group said in a statement.
"Ideally, the new rules would have allowed any borrower with a qualified mortgage to challenge a lender who failed to evaluate if the borrower could afford the loan. However, they do allow borrowers to hold lenders accountable on the riskiest types of mortgages, those in the subprime market where the problems that led to the housing crisis were concentrated."
Nonetheless, the group said there was still a key 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. The CFPB should not create a loophole that allows high-fee loans to count as a qualified mortgage," the group said.
The final rule will be posted here.