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New Mortgage Lending Rule Intended to Protect Borrowers May Hurt Self-Employed

S.Z. Berg

NEW YORK (MainStreet)—Beginning in January 2014, a new mortgage lending rule – the Ability-to-Repay rule, and as part of it, the qualified mortgage criteria – will go into effect. While the rule, which was issued by the Consumer Financial Protection Bureau (CFPB) under the Dodd-Frank Wall Street Reform and Consumer Protection Act, is intended to protect borrowers and the real estate market from another delinquency and foreclosure fiasco like the 2008 housing collapse, it may inadvertently cause headaches for the self employed, including day traders.

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Under the new rule, lenders will no longer be able to offer no-documentation or low-documentation loans or loans with low teaser interest rates that mask their true costs, and they will have to ensure that borrowers can repay the loans.

The CFPB also defined criteria for "qualified mortgages," a new category of loans that protect lenders by ensuring that they are in compliance with the new Ability-to-Repay rule while also protecting consumers.

"Lenders are incentivized to originate qualified mortgages, because doing so makes it easier to defend against borrower lawsuits," says David Reiss, a law professor at Brooklyn Law School. "In return, lenders must ensure that the terms of the mortgage conform with certain requirements that protect borrowers from abusive terms."

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Qualified mortgage loans cannot have interest-only periods, negative amortization, exceed 30 years, and cannot have balloon payments at the end of the term, with exceptions in rural or underserved areas. Further, qualified mortgage loans cannot exceed 43% of the borrower's monthly pretax income, and borrowers must provide proof of income or assets.

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"Determining whether self-employed individuals are able to make the loan payments presents particular challenges," says Reiss. "The Consumer Financial Protection Bureau had originally proposed that self-employed individuals provide heavy documentation of their income, and for the lender to make sophisticated judgments about that income."

In response to comments, the CFPB, in its proposal, subsequently reduced income documentation requirements and the level of lender income analysis required, Reiss says, but adds that "applicants must still demonstrate that their income is stable or increasing."

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The CFPB is currently taking comments.

--S.Z. Berg is the author of College on the Cheap.

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