New Rule Aims To Prevent Predatory Lending
The new Consumer Financial Protection Bureau has just issued what it deems “one of its most important rules to date.” It’s called the Ability To Repay Rule. The rule will ensure that a borrower should be able to afford their mortgage payment. Sounds like common sense, right? Yes and no, according to the agency. The CFPB is trying to prevent the subprime and predatory lending crisis of several years ago by requiring that lenders jump through several strict underwriting hoops for “fail-free” loans.
“When consumers sit down at the closing table, they shouldn’t be set up to fail with mortgages they can’t afford,” CFPB Director Richard Cordray said in a statement. “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 Qualified Mortgage (QM). The key feature of the new rule is the establishment of a “qualified mortgage” — with no risky loan features – such as interest-only payments or balloon payments – and with fees that add up to no more than 3% of the loan amount. In addition, these loans must go to borrowers whose debt does not exceed 43% of their income. These loans would carry extra legal protection for lenders under a two-tiered system that appears to create a compromise between the housing industry and consumer advocates.
End of No-Doc Loans. In the past, lenders could get away with offering low- or no-doc loans (they required few financial documents, if any, from the borrower and then could sell off the risky loans to investors). With the new rule, lenders must do a proper financial background. That means sizing up borrowers’ 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.
Risky borrowers will have a harder time securing a loan. The lender must prove the borrower has “sufficient assets” to pay back the loan eventually. According to the CFPB, that’s determined by calculating debt-to-income ratio of no more than 43%.
Bye-bye to teaser rates. Lenders love to roll out juicy low introductory rates on mortgages to lure borrowers in, but under the new rule, they must calculate a borrower’s ability to repay his loan based on the true mortgage rate –– including both the principal and the interest over the long-term life of the loan.
The rule does not go into effect until January 1, 2014. This new rule has the potential of really shaking up the mortgage industry. We will be tracking future developments. We appreciate comments from mortgage professionals below.