In an effort to forestall a repeat of the 2008 financial crisis, the Consumer Financial Protection Bureau today announced it would issue new mortgage rules designed to ensure that borrowers have the ability to pay back loans before the lender issues them credit.
The new lending standards are a requirement of the 2010 Dodd-Frank Act, which also called for the creation of the CFPB to craft and enforce them. 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 punitive measures should the loan ever fall into foreclosure. This particular provision has drawn the ire of some consumer advocates.
“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,” said Alys Cohen, a staff attorney with the National Consumer Law Center.
According to the new rules, lenders must demonstrate an “ability to repay” by considering eight criteria: income or assets; employment status; the anticipated monthly mortgage payment; other monthly loan payments; monthly mortgage-related expenses such as property taxes and insurance; other debt and payment obligations such as alimony and child support; the monthly debt-to-income ratio; and credit history. Ultimately, borrowers must have a debt-to-income ratio of no more than 43 percent (though there will be some exceptions to this cutoff for the next seven years in an effort to allow the mortgage market to adjust to the change).
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Loans that meet these criteria will be considered Qualified Mortgages (QMs), and as a result lenders will generally be protected from fines or litigation in the event of foreclosure. Non-compliance with the standards, however, will result in significant liability for lenders. According to Cohen, the “safe harbor” provision, along with the debt-to-income ratio standard, are flawed.
“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.”
Other consumer advocates were more measured in their critique. Barry Zigas, director of housing policy with the Consumer Federation of America, was generally pleased with many of the new protections, though he would have preferred that the new rule allow “rebuttable presumption,” which would have generally permitted foreclosed borrowers of Qualified Mortgages to file suit against lenders.
In select situations, however, a borrower who meets the 43 percent criteria may have recourse in the form of rebuttable presumption if, according to the CFPB’s summary of the new rules, “at the time the loan was originated, the consumer’s income and debt obligations left insufficient residual income or assets to meet living expenses.” However, the longer that a borrower is able to make timely payments, the less likely it is that he or she will be able to make a claim like this stick.
“Sadly, the Bureau today took a step back from the highest level of consumer protection by offering lenders a legal safe harbor from any challenges to prime loans meeting the standard, rather than the ‘rebuttable presumption’ that the statute authorized and we strongly advocated in comments on the proposed rule,” Zigas said. He noted, however, that under the final rule, non-prime, higher priced loans would be covered by the rebuttable presumption. “While we would have preferred that the rebuttable presumption applied to all QM loans, we applaud the Bureau’s decision to extend this higher level of protection to those consumers who are at the most risk.”
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Prior to the financial crisis, banks and non-bank lenders issued a variety of mortgages targeting sub-prime borrowers, including interest-only loans, no-doc loans that required no proof of income or employment, and negative amortizing loans, in which the principal actually grew over a period of time.
“In the run-up to the financial crisis, we had a housing market that was reckless about lending money,” said CFPB Director Richard Cordray in a prepared statement. “It had dysfunctional incentives, with lenders being able to off-load virtually any mortgage into the secondary market regardless of the quality of the underwriting. There was broad indifference to the ability of many consumers to repay loans.”
None of the aforementioned exotic loans can be considered a Qualifying Mortgage under the new rules. As a result, with the creation of the Qualified Mortgage category, the CFPB has effectively codified what is to be considered a prime mortgage. Some contend that ultimately these rules will create a kind of line in the sand within the mortgage market.
“What banks have said to us is that they won’t lend outside of Qualified Mortgages. They don’t want face the liability. And it’s reputational,” says Rod Alba, vice president and senior counsel with the American Bankers Association. “The ability to repay standard essentially delineates the market in which they will lend. Every non-QM loan becomes a subprime loan… Independent mortgage lenders might go there, [these are] guys that depend entirely on secondary market financing.”
The issue of QM non-compliance could have other implications, particularly in the area of mortgage-backed securities, the process by which lenders bundle and sell off shares of mortgages to investors. Alba points out that the QM requirements, and the associated liability for non-compliance, transfers to the buyers of mortgage-backed securities.
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“It used to be that a lot of the liability did not transfer up to the loan purchaser. [Now] the liabilities transfer up, ” Alba noted. ”So the secondary market players are threatened with liability and they will go down a more cautionary road when analyzing these rules. We expect additional contract provisions to protect the purchasers of the securities.”
It remains to be seen what impact, if any, the new rules will have on the current housing market. While it is true that the new rule will make it more difficult, if not impossible, for some borrowers to get a mortgage, many feel that these borrowers are already shut out of the mortgage market for all practical purposes.
“To the extent that we limit the availability of credit, then you limit the opportunity for purchases. But today’s credit market is already very conservative,” says the ABA’s Alba. ”I think this rule what it attempts to do is to lock down today’s conservative underwriting standards and say, this is safe. Let’s avoid the excesses of the past. It’s not trying to constrain credit more, but to avoid slipping back to the excesses of the past.”
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