Feds Finalize Rules on Safer Mortgages

By Ruth Mantell, MarketWatch

safer mortgages fed 2013WASHINGTON (MarketWatch) — A federal regulator released final rules on Thursday aiming to clean up the mortgage marketplace by forcing lenders to consider a borrower’s ability to repay a loan, while also offering lenders protection from consumers’ legal actions if loans go bad.

The Consumer Financial Protection Bureau’s rules say that lenders must document borrower characteristics such as employment status, income and credit history, among other items.

“We believe this rule does exactly what it is supposed to do: It protects consumers and helps strengthen the housing market by rooting out reckless and unsustainable lending, while enabling safer lending,” said Richard Cordray, director of the CFPB, in prepared remarks.

Regulators want to prevent the kinds of risky loans that led to the financial crisis from reentering the U.S. mortgage market. Officials also hope that the establishment of clear rules will encourage lenders to loosen standards that are believed to have grown overly restrictive.

“In the end, the ability-to-repay rule will help ensure that lenders and consumers share the same basic financial incentives – both of them win when borrowers can afford their loans,” Cordray said.

The ability-to-repay rules are set to go into effect in January 2014.

As part of the rules released Thursday, regulators also defined a special category of loans that will be considered particularly safe by requiring features such as a cap of 43% for borrowers’ debt-to-income ratios. Temporarily, loans above that 43% threshold can also fall into this special category if they meet certain government standards. The loans also can’t feature interest-only payments or last longer than 30 years, among other prohibited characteristics. Read more about impact of CFPB rules on adjustable-rate mortgages

Analysts expect these special loans, known as “qualified mortgages,” to become the norm because of legal incentives that regulators crafted for lenders. Lenders making qualified mortgages will gain legal protection from borrowers who bring action when loans go bad.

“Banks are not likely to operate outside the legal guarantees offered by the qualified mortgage protections, meaning that the safe harbor rules will largely determine the scope of all future mortgage lending,” according to a statement from the American Bankers Association.

It will be easier for borrowers with higher-cost loans to bring legal action in the case of a loan gone bad. The lending industry is pleased to be gaining protections.

“This approach should allow lenders to offer sustainable mortgage credit to a great number of qualified borrowers without having to risk unreasonable and overly punitive litigation and penalties,” according to a statement from Debra Still, chair of the Mortgage Bankers Association.

However, consumer advocates are concerned that prime borrowers’ rights will be curtailed under the new rules.

“The Consumer Financial Protection Bureau, in creating a legal safe harbor for certain qualified mortgages, has given the industry a protection that does nothing to help consumers,” said John Taylor, president of the National Community Reinvestment Coalition, a consumer advocacy group.

“What the safe harbor does is abridge consumers’ legal rights in favor of lender interests.”

In addition, there’s concern that the CFPB’s rules will be insufficiently flexible to keep up with products that the industry will introduce in coming years.

“No matter how well crafted, QM cannot be foolproof in that it cannot anticipate the future. New products can emerge, and new industry strategies can take hold. Therefore, consumers should have full legal recourse when they are abused in ways that the QM rule does not anticipate,” Taylor said.

Industry participants have their own concerns, commenting in the past that the 43% threshold may be too low. According to a July letter from the ABA, that ratio could reasonably go as high as 50%.

“A borrower’s ability to repay a mortgage loan with a DTI of 43%, 46%, or 50% is not much different,” according to the ABA letter. “Higher DTI cutoffs must be considered in order to prevent unwarranted and unnecessary restrictions to credit access, particularly among minority and lower income mortgage borrowers.”

According to the ABA, an average of 14.3% of mortgages originated between Oct. 1, 2010 and April 1, 2012 had a DTI of at least 43%.

“Given the high underwriting standards currently being utilized, it can be reasonably inferred that setting a DTI of 43% or lower will negatively impact a significant portion of borrowers who would otherwise qualify for credit even under today’s stringent underwriting standards,” according to the ABA letter.