The Consumer Financial Protection Bureau (CFPB) has adopted a final rule giving lenders more guidance about making mortgage loans and giving consumers – especially lower income consumers – additional protection against predatory lending.
At least, that's the objective. The new regulation, which took effect in January, bars lenders from offering those low “teaser” rates that prompted a lot of buyers to purchase homes they couldn't afford. When the rates on these subprime mortgages reset to double-digit levels in some cases, the monthly payments were unaffordable.
As a result, a wave of foreclosures began to build within the housing market that not only devastated housing but threatened to topple the international banking system. The new rules are designed to prevent a repeat of that catastrophe by requiring lenders to take more steps to make sure their borrowers will be able to repay their loans.
The rules restrict upfront fees and set limits on balloon payment and interest-only loans, which were common subprime lending practices. At a minimum, creditors must now consider eight underwriting factors:
- Current or reasonably expected income or assets;
- Current employment status;
- The monthly payment on the covered transaction;
- The monthly payment on any simultaneous loan;
- The monthly payment for mortgage-related obligations;
- Current debt obligations, alimony, and child support;
- The monthly debt-to-income ratio or residual income;
- Credit history.
Creditors must generally use reasonably reliable third-party records to verify the information they use to evaluate the factors.
Hopeful But Skeptical
Will these new rules make a difference? The experts we talked to are hopeful but somewhat skeptical.
“With regard to the definition of qualified mortgages, I am somewhat dubious that new regulations will lead to a renaissance of 'good credit judgment' on the part of mortgage lenders and investors,“ said Sidney Bostian, a professor of finance and real estate at Virginia Commonwealth University.
He does say that, under the new rules, risk will likely be priced more realistically. The net effect, he says, is that some income groups will be priced out of the market. Other experts agree.
“Ability to pay puts pressure on the lenders not to make loans where the loans never should have been given in the first place,"said Russell McClain, a professor at the University of Maryland School of Law. "But it also restricts lending – perhaps too much in theory – preventing consumers who may need loans the most from getting them.“
More Needed Than a Definition
James Fanto, a professor at Brooklyn Law School, admits to being skeptical that the definition for “Qualified Mortgages” under the new rules will, on its own, promote responsible lending practices.
“So long as loans are securitized, there will be a structural issue related to responsible lending: the lenders don’t hold on to the loans, even if, under the new law, they must maintain a certain share of them,” he said. “Instead, they sell them off. Moreover, Fannie Mae and Freddie Mac had lending standards before the financial crisis. This did not prevent them from buying up Alt-A and subprime mortgage-backed securities. ”
The new rules will, at long last, provide some firm guidelines for the lending industry that has erred on the side of caution over the last four years. While the real estate industry is hopeful the new rules will place the recovering housing market on even firmer footing, our experts are taking a “wait and see” attitude.
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