The Federal Reserve Board has proposed a rule that would require banks to determine a borrower’s ability to repay a mortgage before making the loan.
Although this rule seems obvious, it is now required by the Dodd-Frank act, which also establishes minimum mortgage underwriting standards. This means borrowers can sue lenders if appropriate efforts are not taken to ensure they can repay the loan.
The proposed rule is in response to a spate of so-called “liar loans” that lenders offered to borrowers in the years leading up to the housing market crash. In many cases, lenders did not verify the income stated by borrowers, which meant no due diligence was made to determine the borrower’s ability to repay. Many of these liar loans ended up on foreclosures, which contributed further to the nation’s financial crisis. Some of the criteria that will be used to determine a borrower’s credit worthiness and ability to repay a mortgage loan include a person's income, employment status, the monthly mortgage payment, any other current debt obligations and a consumer's credit history.
The revisions to mortgage regulation, which implements the Truth in Lending Act (TILA), are being made following the implementation of the Dodd-Frank Wall Street Reform and Consumer Protection Act. The proposal would apply to all consumer mortgages except home equity lines of credit, timeshare plans, reverse mortgages, or temporary loans.
The proposed rule would provide four options for complying with the ability-to-repay requirement.
Although this rule seems obvious, it is now required by the Dodd-Frank act, which also establishes minimum mortgage underwriting standards. This means borrowers can sue lenders if appropriate efforts are not taken to ensure they can repay the loan.
The proposed rule is in response to a spate of so-called “liar loans” that lenders offered to borrowers in the years leading up to the housing market crash. In many cases, lenders did not verify the income stated by borrowers, which meant no due diligence was made to determine the borrower’s ability to repay. Many of these liar loans ended up on foreclosures, which contributed further to the nation’s financial crisis. Some of the criteria that will be used to determine a borrower’s credit worthiness and ability to repay a mortgage loan include a person's income, employment status, the monthly mortgage payment, any other current debt obligations and a consumer's credit history.
The revisions to mortgage regulation, which implements the Truth in Lending Act (TILA), are being made following the implementation of the Dodd-Frank Wall Street Reform and Consumer Protection Act. The proposal would apply to all consumer mortgages except home equity lines of credit, timeshare plans, reverse mortgages, or temporary loans.
The proposed rule would provide four options for complying with the ability-to-repay requirement.
· First, a lender can meet the general ability-to-repay standard by considering and verifying specified underwriting factors, such as the borrower’s income or assets.
· Second, a lender can make a "qualified mortgage," which provides the creditor with special protection from liability provided the loan does not have certain features, such as negative amortization; the fees are within specified limits; and the creditor underwrites the mortgage payment using the maximum interest rate in the first five years.
· Third, a lender operating primarily in rural or underserved areas can make a balloon-payment qualified mortgage. This option is meant to preserve access to credit for consumers located in rural or underserved areas where banks originate balloon loans to hedge against interest rate risk for loans held in portfolio.
· Finally, a lender can refinance a "non-standard mortgage" with risky features into a more stable "standard mortgage" with a lower monthly payment. This option is meant to preserve access to refinancing.
The proposal would also implement the Dodd-Frank Act's limits on prepayment penalties. The Fed is seeking comments on the proposed rule until July 22, 2011. The process of writing rules based on the Fed’s proposal is scheduled to transfer to the soon-to-be-effective Consumer Financial Protection Bureau (CFPB).
The Dodd-Frank Act requires the creation of this bureau, which will write rules for mortgages and other consumer credit products. The CFPB will take over enforcement of consumer protection laws on July 21.
