June 27th, 2014 5:09 PM by Dan Marchiando
The Consumer Financial Protection Bureau’s (CFPB) Ability-to-Repay (ATR) Rule went into effect January 2014. The rule was designed to protect consumers from getting trapped in mortgages that they cannot afford, by requiring mortgage lenders to evaluate whether borrowers can afford to pay back a mortgage before signing them up. The rule was required by Congress with passage of the 2010 Dodd-Frank Act, in response to the financial crisis and nationwide foreclosure epidemic. Congress was also no doubt motivated by the recession to pass Dodd-Frank—to provide some protection to the larger economy from collateral damage due to future crises in the banking and housing industries.
The ATR rule applies to loans made on residential properties from 1-4 units, and applies regardless of whether the property is the borrower’s primary residence, vacation home, or residential investment property. Certain types of loans are exempt from the ATR rule, like some Home Equity Lines of Credit (HELOCs), and reverse and commercial mortgages.
The Ability-to-Repay Rule puts into law conservative but common-sense practices that most lenders were already following since the financial crisis started. The mortgage lenders who survived the widespread failure of banks, long since stopped making risky and exotic Stated-Income, Easy-Documentation, Low-Documentation, and No-Documentation loans. So the Ability-to-Repay Rule has not caused a dramatic reduction in the availability of loans in 2014, because lenders were already requiring full documentation of income and assets. But the ATR will make the return of easy-documentation loans unlikely anytime soon.
Under the ATR, mortgage lenders must look at customers’ documentable income, assets, and savings, and weigh those against the borrowers’ monthly housing payments and other monthly debts. Also, lenders can no longer qualify borrowers based on teaser or introductory interest rates offered on ARM loans—and pre-payment penalties are severely restricted. The Ability-to-Repay Rule does not require lenders to offer any specific type of mortgage—lenders can offer any type of mortgage they reasonably believe a consumer can afford to repay. But lenders do have to evaluate the numbers on the borrowers’ documents, and retain documentation to back up their assessment. In practice, today’s lenders stopped making exotic and complicated loans a few years ago. Features like Negative Amortization and 1% teaser rates—that failed lenders like Washington Mutual, Countrywide, and World used to have—are not currently being offered. And it seems unlikely those types of loans will return anytime soon.
The biggest impact of the loss of Stated-Income and Low-Documentation loans has been to self-employed borrowers who have a lot of write-offs that reduce their taxable income. Some self-employed borrowers may be forced to claim fewer tax deductible expenses in the future, which will require them to pay more taxes, just so they can qualify for loans.
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