New federal rule: Make sure borrower can pay loan

After months of discussion, the Consumer Financial Protection Bureau has come out with rules it says will help protect consumers from toxic mortgages.

The new “Ability to Repay” rule is designed to make lenders determine that borrowers can actually pay back their mortgages. Lenders whose loans follow the guidelines for what is called a "Qualified Mortgage" are protected against certain lawsuits. While lenders can issue mortgages outside the rules, they won’t have the same legal protections.

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The rules don’t include any guidelines about the size of a down payment. There had been much speculation during the two years that the rule was under discussion that a qualified mortgage would include a 20% down payment. That didn’t happen, though the CFPB is planning to issue more rules on mortgages later.

The new rules essentially end the no-doc and low-doc “liar loans,” in which customers did not have to document their income. The rules also limit borrowers’ debt-to-income ratio to 43% in most cases. Interest-only and negative amortization loans don’t qualify, and the qualified mortgages will limit fees.

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Whether the rules will do anything to make loans more available is a big question. In general, the standards are similar to those lenders are using on their own now.

The rules will take effect in January 2014. You can read them here and see an analysis by the Center for Responsible Lending here. The Wall Street Journal has a Q&A.

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The housing industry and consumer advocates generally praised the new rules.

"The Consumer Financial Protection Bureau’s new rules generally strike a balanced, reasonable approach to mortgage lending and implement important consumer protections," the Center for Responsible Lending wrote in a news release. "The standard CFPB establishes for a safe, well-underwritten mortgage is appropriately broad enough to include the vast majority of creditworthy homeowners, and  it is clear enough for lenders and borrowers alike to understand. And the rules preserve legal protection for borrowers with the riskiest loans."

Barry Rutenberg, chairman of the National Association of Home Builders, said in a statement that his organization "is encouraged that regulators heeded concerns from the housing industry to craft a broad standard that includes many of today's sound mortgage products, including fixed-rate and adjustable-rate mortgages, under the QM standard."

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The new rules were required by the 2010 Dodd‐Frank Wall Street Reform and Consumer Protection Act, which called for restricting mortgages to people who had the ability to pay them back – something that wasn’t a concern during the heady days of the real-estate boom.

"In the run-up to the financial crisis, we had a housing market that was reckless about lending money," CFPB Director Richard Cordray wrote on the agency’s blog. "Lenders thought they could make money on a loan even if the consumer could not pay back that loan, either by banking on rising housing prices or by offloading the mortgage into the secondary market. This encouraged broad indifference to the ability of many consumers to repay loans, which dramatically increased mortgage delinquencies and rates of foreclosures."