The Consumer Financial Protection Bureau released comprehensive new rules on January 10, 2013, aimed at fixing the home lending market. The sweeping new standards stem from the 2010 Dodd-Frank Act and are designed to prevent a repeat of the 2008 financial and housing crisis.
A major portion of the new rules are directed at borrowers to ensure they have the ability to repay a mortgage loan before the lender issues them credit.
The rules will compel lenders to verify consumers’ ability to repay loans in a variety of ways, and in return, the lenders will enjoy what is being referred to as a “safe harbor” from legal actions if the mortgage loan ever goes into foreclosure.
In order for lenders to claim “safe harbor” they must demonstrate an “ability to repay” by considering eight criteria:
(1) Income or assets;
(2) Employment status;
(3) The anticipated monthly mortgage payment;
(4) Other monthly loan payments;
(5) Monthly mortgage-related expenses such as property taxes and insurance;
(6) Other debt and payment obligations such as alimony and child support;
(7) The monthly debt-to-income ratio; and
(8) Credit history.
Borrowers must also have a debt-to-income ratio of no more than 43 percent which means a borrower’s total payments, including those for property taxes, fire insurance and non-housing debt such as credit cards are limited to 43% of gross income.
Loans that meet these criteria will be considered Qualified Mortgages (QMs) and protected from fines or litigation in the event of foreclosure. But non-compliance with the standards will result in significant liability for lenders.
During the housing boom, some lenders had set the bar at 50% or higher for mortgage payments alone and allowed borrowers to qualify by merely stating their incomes, with no documentation required.
By complying with the rules lenders can avoid being sued for one of the main causes of the housing crisis — sticking borrowers with subprime, unaffordable loans. Certain subprime loans to borrowers with credit problems could be considered Qualified Mortgages (QMs), but not the “No Documentation” loans that helped fuel the housing crisis .
The “safe harbor” aspect of the new rules has consumer advocates calling foul. One leading consumer advocate said the bureau had gone too far out of its way to accommodate bankers, whose loose lending criteria triggered the foreclosure and economic crisis.
Alys Cohen, an attorney with the National Consumer Law Center, said “…The bureau’s action invites abusive lending and erodes the progress made by Dodd-Frank. The safe harbor the bureau has afforded for prime loans provides absolute shelter to lenders who knowingly make unaffordable loans, in direct violation of congressional intent.”
“The Consumer Financial Protection Bureau’s Qualified Mortgage rule invites abusive lending and erodes the progress made by Dodd-Frank,” Cohen said, going on to criticize the implications of the 43% debt-to-income ratio for low-income families. “The 43 percent debt-to-income ratio in the rule may be a reasonable standard for a homeowner earning $10,000 per month, but for a homeowner earning only $1,000 per month, 43 percent does not leave enough to pay the utility bills or other essentials.”
Consumer Financial Protection Bureau Director Richard Cordray said the aim was to achieve “the true essence of ‘responsible lending. The American dream of homeownership was shaken to its foundations. But, in the wake of the financial crash, we have been experiencing a housing market that is tough on people in just the opposite way — credit is achingly tight.”
The new rules will be phased in over the coming year so it remains to be seen if they do what is intended, to create a stable and predictable housing finance system for banks and their customers alike.