On January 10, 2014, the Consumer Financial Protection Bureau released
new rules that will regulate how banks issue mortgages. These rules are
designed to prevent banks from issuing the types of sub-prime and Alt-A
loans that were largely responsible for the mortgage bubble and the financial
collapse that followed.
The new rules have two main categories: "Ability to Repay" rules
and "Qualified Mortgage" rules. All loans must conform with
the Ability to Repay rules. However, if banks issue loans that fall within
the "Qualifed Mortgage" rules, then it is presumed that they
fall within the "Ability to Repay" rules. Borrowers who take
out qualified mortgages will know that they are taking out a loan that
they can repay.
Under the umbrella of the "Ability to Repay" rules, the CFPB
has eliminated many features of subprime loans that could be described
as predatory lending terms. For example, the borrower's ability to
repay cannot be based upon a low teaser rate which will ultimately balloon
to a much higher rate. The ability to repay must be determined over the
lifetime of the loan.
Another new rule prohibits lenders from issuing no-documentation or low-documentation
loans (sometimes called "liar loans"). These loans were one
of the primary culprits behind the implosion of the housing market --
lenders would issue them and quickly re-sell them on the secondary market.
Investors ultimately took the loss on these loans. Banning these loans
means that borrowers must be able to document their ability to repay.
The rules for "Qualified Mortgages" are designed to generate
repayble loans that do not contain toxic provisions which doom the loan
to fail in the future. For example, the new rules set limits on up-front
points and fees that were used to compensate mortgage brokers and loan
officers. By limiting these kinds of fees, borrowers are protected --
they will only pay what they expect to pay.
Qualified mortgages cannot contain high-risk features. During the mortgage
bubble, borrowers were issued loans with interest-only payments, negative
amortization (when a principal balance increases over time), and terms
exceeding 30 years. These types of loans, as well as "pick-a-pay"
loans will not be allowed under the "Qualified Mortgage" rules.
Although these risky loans appear to be a good deal at the outset, they
often spiral out of control, leaving borrowers unable to continue to make payments.
Qualified mortgages will require a debt-to-income (DTI) ratio of 43%. There
will be a safe-harbor period where a DTI over 43% will be acceptable so
long as the loans conform with the underwriting standards of Fannie Mae
or Freddie Mac.
I will be writing about these lending changes more after I have fully reviewed
the rules and proposed amendments. These rules go into effect in January 2014.
You can read the CFPB's press release