Consumer Regulator Toughens Mortgage Restrictions for Banks

By Daniel Duffield

The consumer regulator for the federal government issued a statement on Thursday that banks will be given stricter rules for mortgage lending when assessing borrowers’ ability to repay home mortgages, in an attempt to avoid the loose regulations to which the recession was partially attributable.

With new restrictions, banks will be forced to verify borrowers’ income, debt, and employment.

The Consumer Financial Protection Bureau (CFPB) stated that its new requirements would also shield borrowers from irresponsible lending practices by giving incentives for lenders providing safer, lower-price loan products, primarily less legal accountability.

The mortgage industry, which has spent billions within the past year in litigations regarding falsified loan documents and aggressive lending to borrowers who were unable to afford their mortgages, will now reward safer lending and those issuing “qualified mortgages.”

According to Richard Cordray, the director of the CFPB, lenders should not enable borrowers to acquire mortgage loans for home purchases that they will be unable to repay.

With this reform, financial watchdogs intend to breathe new life into the house financing market and stimulate the industry, which as of late has been lethargic in the wake of the credit crisis and the new restrictions on bank action.

Lenders and consumer organizations have anticipated these new guidelines, which have been among the most hotly debated updates since the 2010 Dodd-Frank financial reform law.

Many analysts had been apprehensive regarding the new definitions of a “qualified mortgage,” fearing that this would narrow the type of loans currently available. However, mortgage bankers have expressed satisfaction with these updates and specifically remarked about the advantages of the legal protection provided for those issuing these safer mortgages.

According to a statement from Debra Still, chairman of the Mortgage Bankers Association (MBA), this new outlook will incentivize the extension of more sustainable mortgage credit to qualified borrowers without having to worry about future litigation or penalties. 

While some consumers questioned whether the rules provided too much protection for lenders, the general consensus was a welcoming of these changes. Mike Calhoun, president of the Center for Responsible Lending, commented that these updates give a “reasonable approach to mortgage lending,” adding that such changes will facilitate a more competitive and invigorated housing recovery.

Safer Guidelines for Lenders

Essentially, Dodd-Frank regulators designed a new category of “qualified mortgages” that would automatically comply with all ability-to-repay requirements. This regulation was first created by the Federal Reserve, and then passed on to the consumer bureau in July 2011.

The CFPB stated that these “qualified mortgages” would include those with no risky aspects, such as interest-only mortgages or balloon payments, and include no fees that constitute more than 3% of the loan amount, making them more affordable. Additionally, these loans could only be issued to borrowers with debt-to-income ratios (DTI) of 43% or less. As previously indicated, these loans would include provisions with extra safeguards for lenders willing to issue these types of mortgages.

While bank groups had supported the redefinition of these mortgages to all qualified loans, thereby removing some of consumer rights to litigation on mortgages that they could repay, consumer groups advocated just the opposite: less protection for banks and lenders from consumer lawsuits. 

With these new guidelines, most protection would be delegated to cheaper, qualified mortgages, since, according to the bureau, these prime loans would be assigned to less-risky consumers with decent credit histories.

In contrast, more expensive mortgages would get less protection, as lenders would be expected to verify that their income was adequate. Borrowers could, however, pursue litigation if they prove that they could not afford the mortgage along with other living expenses.

Availability of Credit

While the reception has generally been favorable, some lawmakers and lenders were anxious that strict rules would worsen the credit crisis that has afflicted the mortgage market and delayed the both the real estate and economic recovery in the U.S. Despite these fears, the CFPB addressed these concerns by creating the rules that facilitated a smooth transition that would not disrupt the current trends in credit.

Moreover, these rules initiated a new category of loans that would temporarily be regarded as qualified. These loans could be granted to borrowers with DTI ratios greater than 43%, provided they satisfied the underwriting guidelines of Fannie Mae, Freddie Mac, or one of the other U.S. government housing agencies such as the Federal Housing Administration (FHA).

According to the CFPB, banks will be given until January 2014 to make the appropriate adjustments in complying with these new standards.

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