It is well known that in the years leading up to the financial crisis, too many mortgages were made to consumers without taking into account a consumer’s ability to repay the loans, contributing to a mortgage crisis that led to a serious recession in the United States.
In response to lessons learned from the financial crisis, the U.S. government implemented a variety of rules and regulations hoping to prevent future crises, including the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”) passed by Congress in 2010. The Dodd-Frank Act requires that for residential mortgages, creditors must make a reasonable and good faith determination based on verified and documented information that the consumer has a reasonable ability to repay the loan.
Most recently, in January 2013, the Consumer Financial Protection Bureau (CFPB)–the agency charged with implementing the Dodd-Frank Act–issued a final rule, referred to as the Ability-to-Repay/Qualified Mortgage rule (“ATR/QM Rule”). The rule, which will go into effect January 2014, not only forces mortgage lenders to consider a consumers’ ability to repay home loans before extending them credit, but also establishes a new category of loans that have more stable features called Qualified Mortgages (“QMs”). The new measures do not set minimum down payment amounts or credit score requirements. Finally, although the ATR/QM Rule applies to most mortgage loans, it excludes certain types of loans, including home equity lines of credit, timeshare plans, reverse mortgages, and temporary loans.
The Ability-to-Repay rule has a variety of features, including the following:
• To qualify for a particular loan, a consumer has to have sufficient assets or income to pay back the loan;
• Lenders must determine a consumer’s ability to repay both the principal and the interest over the long term–not just during the introductory period; and
• A potential borrower must supply verifiable financial information to the lender (e.g., W-2, pay stubs)
Specifically, the lender must generally consider the following information:
1) Current or reasonably expected income or assets;
2) Current employment status;
3) The monthly payment for the mortgage;
4) The monthly payment on any other mortgage loans received at the same time;
5) The monthly payment for other mortgage-related expenses (e.g., property taxes)
6) Other debts (e.g., alimony and child support);
7) Monthly debt payments, including the mortgage, compared to consumer’s monthly income (“debt-to-income ratio”); and
8) Credit history
Qualified Mortgage Rule
In addition to the new guidelines, the final rule also creates a new category of loans, Qualified Mortgages, where borrowers would be the most protected. A QM cannot include risk features, such as extending beyond 30 years, nor can it include exotic terms like interest-only payment or negative-amortization payments where the principal amount increases. Moreover, a mortgage will only qualify as a QM if the borrower’s total monthly debt (including car loans, student loans, credit card debt, etc.) is less than 43% of the borrower’s monthly pre-tax income. Finally, mortgages in which fees and points cost more than 3% will not be considered QMs. Temporarily, QMs can also be loans that can be bought by Fannie Mae or Freddie Mac, or insured by certain government agencies, such as the Federal Housing Administration.
Notably, in return for following these criteria and properly assessing a borrower’s ability to repay his or her loan, a lender will receive protection and, for the most part, cannot be sued if the borrower defaults.
Though the ATR/QM Rule may make it more difficult for borrowers to qualify for loans, the new guidelines created provide more clarity for lenders and consumers on what constitutes a safe mortgage. It also makes sure that responsible lenders are not forced to compete with lenders engaged in reckless and risky practices.
However, since banks have clearer guidelines as to what constitutes an acceptable loan, they are less likely to lend to consumers that fail to meet the criteria. This means that if you are planning to purchase a home or refinance your mortgage, you will now need a substantial down payment, good credit, minimal debt, and the proven ability to pay back the loan with secure income.
Cirrus Law PC advises and represents mortgage brokers, real estate companies and brokers, and other financial professionals in Northern California in matters involving mortgage law. If you have any questions about the Ability-to-Repay/Qualified Mortgage Rule, contact the Pleasanton Real Estate lawyers at Cirrus Law PC using our online contact form, or by calling us at 925-463-1073.
Ability to Repay and Qualified Mortgage Standards under the Truth in Lending Act (Regulation Z), Consumer Financial Protection Bureau
Could New Tighter Mortgage Actually Ease Lending?, by Morgan Brennan, Forbes
U.S. Consumer Watchdog to Issue Mortgage Rules, by Edward Wyatt, The New York Times