The Consumer Financial Protection Bureau has issued a long-awaited rule designed to prevent a repeat of the irresponsible mortgage-lending standards that contributed to the crash of the housing market and the financial crisis.
The watchdog set the standards that lenders will have to follow to ensure borrowers have the ability to repay their mortgages. The rule may sound like common sense, but it will help determine which borrowers will get approved for a mortgage and what type of loans they will be able to get.
The ability-to-repay rule, mandated by the Dodd-Frank financial reform law, goes into effect a year from now. Lenders will begin to adapt to the new requirements in the next few months, says David Stevens, chief executive officer of the Mortgage Bankers Association.
How will borrowers be affected?
The CFPB's definition of a qualified mortgage shouldn't make mortgage loans harder to get for most borrowers, according to consumer advocates and the Mortgage Bankers Association.
But it may hurt borrowers in high-cost areas who need larger mortgages, known as jumbo loans, says Anthony Hutchinson, senior policy representative of financial services at the National Association of Realtors.
"There's some anxiety around that, especially if the loan limits come down," he says.
That's because under the new rules, borrowers who need a loan outside the conforming loan limits set by Fannie Mae and Freddie Mac will not have access to a so-called qualified mortgage if the borrower's total monthly debt payments, including the mortgage, are higher than 43 percent of the borrower's pretax income. The conforming limits are $417,000 in most parts of the country and $625,500 in high-cost areas such as San Francisco and New York.
"It's going to cut out about 25 percent of all jumbo loans," Stevens says.
The 43 percent debt-to-income cap actually applies to both conforming and nonconforming loans, but the CFPB created a temporary alternative that allows lenders to issue safe mortgages to borrowers with higher DTIs, as long as the loans meet existing standards set by Fannie Mae, Freddie Mac, or standards for loans such as United States Department of Agriculture and Veterans Affairs mortgages.
This alternative will stay in place for up to seven years, according to a summary of the rule released by the CFPB on Thursday.
Exceptions for certain refinancers
The industry also had some concerns about how the debt-to-income limitation would affect borrowers seeking to refinance their loans through many of the government-sponsored refinance programs that were designed to help struggling borrowers avoid foreclosure. The rule has exceptions to allow lenders to refinance loans for borrowers who have risky mortgages (such as adjustable-rate and interest-only loans) without meeting the ability-to-repay requirements.
The CFPB is in the process of considering proposals to amend the final rule to prevent issues for these special refinance programs.
Basics of a qualified mortgage
Based on what the CFPB has released so far, these are the main aspects of the qualified-mortgage rule:
- It limits the upfront points and fees that lenders can charge borrowers to 3 percent of the total of the loan.
- No more interest-only loans, negative-amortization loans (in which the borrower makes the minimum payment at the beginning of the month and owes more at the end of the month) or loans with terms longer than 30 years.
- Caps the borrower's DTI to 43 percent.
Lenders are allowed to issue loans that don't meet the qualified mortgage standards, but when they do so, they give away some broad legal protections they gained with the ability-to-pay rule.
Safe harbor and consumer's right to sue their lenders
If lenders follow the requirements to issue a qualified mortgage, the lender will have "legally satisfied the ability-to-repay requirements," according to the CFPB. This "safe harbor" provision will make it extremely difficult for borrowers to sue or challenge the lender in court in case of foreclosure, some consumer advocates say.
Lenders were not given the same level of protection for subprime loans. After defaulting on a subprime mortgage, the borrower can sue the lender and challenge whether or not the lender took the necessary steps to ensure the borrower could afford the loan.
"I am disappointed that they bifurcated the legal standards," says Julian Gordon, director of housing finance and policy for the Center for American Progress.
Gordon says the safe harbor that was extended to the mortgage banking industry won't prevent borrowers from suing their lenders, but it will make it cost-prohibitive and challenging.
Mike Calhoun, president of the Center for Responsible Lending, says: "Ideally, the new rules would have allowed all holders of a qualified mortgage to challenge loans when lenders don't follow the law. 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."
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