The Consumer Financial Protection Bureau has announced a new rule (the “Ability-to-Repay rule”) requiring mortgage lenders to ensure that potential borrowers will be able to repay their mortgages. The CFPB is charged with amending Regulation Z, which carries out the Truth in Lending Act. The CFPB also implements the ability-to-repay requirements under the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”). Under Dodd-Frank, creditors must make a reasonable and good faith determination that borrowers have a reasonable ability to repay the loan.
The Ability-to-Repay rule is aimed at protecting American consumers. According to the CFPB Director, the “Ability-to-Repay rule protects borrowers from the kinds of risky lending practices that resulted in so many families losing their homes.”
Under the new rule:
- 1. Lenders are required to obtain and verify financial information from potential borrowers,
- 2. Lenders must evaluate and conclude that potential borrowers have sufficient assets or income to repay the loan, and
- 3. Lenders cannot use lower, introductory “teaser” interest rates (which cause monthly payments to jump to unaffordable levels) to base their evaluation of a potential borrower’s ability to repay the loan.
In assessing whether a borrower will be able to repay their loan, lenders must generally consider the following underwriting factors: 1) current or reasonable expected income or assets, 2) current employment status, 3) the monthly payment, 4) monthly payment on any simultaneous loan, 5) the monthly payment for mortgage-related obligations, 6) current debt obligations, 7) monthly debt-to-income ratio, and 8 ) credit history.
Under the new rule, lenders are also required to issue Qualified Mortgages (“QMs”). The features of QMs include:
- 1. Limited up-front points and fees to compensate loan originators,
- 2. No risky loan features — such as terms that exceed 30 years, interest-only payments or negative amortization payments, and
- 3. A cap on how much income can go toward debt such that QMs will be provided to potential borrowers with debt-to-income ratios less than or equal to 43 percent.
Generally, there are two types of QMs: 1) those that are subject to a rebuttable presumption that borrowers had an ability to repay the loan, and 2) others that have a safe harbor status. The former are higher-priced loans given to borrowers with weak credit history. More specifically, if loan originators follow certain requirements in connection with issuing subprime loans, the loans are subject to a rebuttable presumption of compliance. Borrowers may rebut the presumption of the ability to repay by showing that, at the time the loan was originated, the borrower’s “income and debt obligations left insufficient residual income or assets to meet living expenses.” The latter type of QMs are lower-priced loans issued to less risky borrowers. If the loan satisfies the QM criteria described above, it will be conclusively presumed that the lender made a reasonable determination as to the borrower’s ability to repay the loan.
Individuals in the lending industry have expressed concern about overregulation of lending practices – and Dodd-Frank in particular. For instance, David Steven, chief executive of the Mortgage Bankers Association said that if the new rule is too restrictive, “qualified borrowers will not have the opportunity to access mortgage credit, and homeownership opportunities will not be there for anyone but the most wealthy.”
The Ability-to-Repay rule will take effect on January 10, 2014.