A landmark overhaul of federal mortgage regulations is on its way to help prevent the kind of abusive mortgage practices that contributed to bringing down the housing market and ruining the economy.
Many mortgage lenders have already taken steps to comply with the mortgage rules – the Ability to Repay rule and Qualified Mortgages (QM) – which are effective in 2014, when all Consumer Financial Protected Bureau (CFPB)-regulated mortgage lenders must fall in line.
The rules, the first of seven new mortgage regulations, protect consumers from irresponsible mortgage lending by requiring lenders to be certain morgage borrowers have a real ability to repay their mortgage.
The rules protect borrowers from risky lending practices such as “NINJA” (no income, no job or assets) and “interest only” features that contributed to high mortgage delinquencies and foreclosures after the 2008 housing crash.
“When consumers sit down at the closing table, they shouldn’t be set up to fail with mortgages they can’t afford,” said CFPB Director Richard Cordray.
“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.”
The 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act mandates the changes, which the CFPB must impliment.
Here’s a quick rundown of the two provisions – the Ability to Repay and Qualified Mortgages (QMs).
Ability to Repay
Under the Ability-to-Repay rule, all new mortgages must comply with basic requirements that protect consumers from loans they can’t afford, according to the CFPB. The requirements include:
• Proof of employment, financial status – Lenders must document employment status; income and assets; current debt obligations; credit history; monthly payments on the mortgage; monthly payments on any other mortgages on the same property; and monthly payments for mortgage-related obligations. For CFPB regulated lenders, this outlaws so called no-doc and low-doc loans.
• Proof of sufficient debt to income ratio – Lenders must evaluate and conclude that the borrower can repay the loan. For example, lenders may look at the consumer’s debt-to-income (DTI) ratio – their total monthly debt divided by their total monthly gross income. The DTI helps a lender determine how much more debt a consumer can take on.
• Unmasking a mortgage’s true cost – Lenders must determine a borrowes’s ability to repay both the principal and the interest over the long term – not just during an introductory “teaser rate” period when the rate may be lower.
Lenders effectively comply with Ability-to-Repay rule if they issue QMs. These loans must meet certain requirements which prohibit or limit abusive, predatory features that cost millions of consumers their homes during the mortgage crisis, says CFPB.
Qualified Mortgages include:
• No excess upfront points and fees – QMs limit points and fees, including those used to compensate loan originators, including loan officers and mortgage brokers. Excessive points and fees tacked onto origination costs cause consumers to pay more than planned.
• No toxic loan features – QMs cannot have risky features, including terms that exceed 30 years, interest-only payments, or negative-amortization payments that cause the principal to increase.
• DTI caps - QMs generally will be provided to people who have debt-to-income ratios less than or equal to 43 percent to help ensure consumers get mortgages they can most likely afford. CFPB said for a temporary, transitional period, loans that do not have a 43 percent debt-to-income ratio but meet government affordability or other standards, will be considered QMs. Those other standards include mortgages that are eligible for purchase by the Federal National Mortgage Association (Fannie Mae) or the Federal Home Loan Mortgage Corporation (Freddie Mac).
Two types of Qualified Mortgages
• Qualified Mortgages that have a safe harbor status, are generally lower-priced loans. They are generally prime loans that are given to consumers who are considered to be less risky. They will also offer lenders the greatest legal certainty that they are complying with the new Ability-to-Repay rule. Consumers can legally challenge their lender if they believe the loan does not meet the definition of a Qualified Mortgage.
• Qualified Mortgages with a rebuttable presumption, are higher-priced loans. These loans are generally given to consumers with insufficient or weak credit history. Legally, lenders that offer these loans are presumed to have determined that the borrower had an ability to repay the loan. Consumers can challenge that presumption, though, by proving that they did not, in fact, have sufficient income to pay the mortgage and their other living expenses.
The Ability-to-Repay rule does not affect the rights of a consumer to challenge a lender for violating any other federal consumer protection laws.
Additional Ability to Repay amendments coming
The CFPB also announced proposed amendments to the Ability-to-Repay rule, which, among other things would exempt certain nonprofit creditors that work with low- and moderate-income consumers. The proposed amendments would also make exceptions for certain foreclosure prevention homeownership stabilization programs, including the Obama Administration’s Making Home Affordable programs.
The proposed amendments would also provide Qualified Mortgage status for certain loans made and held in portfolio by small creditors, including community banks and credit unions.