The Consumer Financial Protection Bureau today released its final rule regarding the “ability-to-repay” provision included in the Dodd-Frank Wall Street Reform Act. The rule requires lenders to consider whether a borrower can afford a mortgage before giving it to them, and it will make a significant difference in preventing the type of predatory lending practices that crashed the U.S. market and stripped families of trillions of dollars of household wealth.
According to CFPB Director Richard Cordray, who spoke in Baltimore today, the rule could have prevented the worst of the 2008 financial crisis:
I firmly believe that if the ability-to-repay rule we are announcing today had existed a decade ago, many people…could have been spared the anguish of losing their homes and having their credit destroyed. The events that caused the financial crisis might well have been averted. The tragic reverberations that continue to affect so many Americans today would never have occurred…We believe this rule does exactly what it is supposed to do: It protects consumers and helps strengthen the housing market by rooting out reckless and unsustainable lending, while enabling safer lending.
Under the Dodd-Frank law, lenders get special protections from liability if they make loans that are presumed to be safe and sustainable based on certain product features and underwriting practices. This category of loans is called a “qualified mortgage” or “QM.”
Over the past two years, regulators have pored over the finer details of the rule, including the legal implications of stamping a loan as a QM. Mortgage lenders have pushed for full exemption from liability — or “safe harbor” — for these loans, meaning borrowers can’t take the lender to court if it turns out the loan was improperly underwritten. Consumers are understandably leery of that sort of “get out of jail free” card, and have pushed to preserve some rights in the event of blatant fraud or other misconduct.
In the end, the CFPB chose a compromise. Under the final rule, lenders are granted a safe harbor on prime-rate loans deemed as QM, while the lenders are granted fewer protections on higher-priced loans that fit the QM definition. Unfortunately, the large safe harbor makes it more difficult for consumers to enforce this rule than was originally envisioned by lawmakers.
One detail yet to be finalized is the amount originators can charge in points and fees on QM loans. The QM definition contains a cap on such fees, but today the CFPB announced that it was considering exempting lender payments to loan originators known as “yield spread premiums.” During the housing bubble, these back-door payments encouraged originators to sell borrowers the unnecessarily risky and expensive loans that triggered the financial crisis. Regulators should keep those payments in the definition of the cap to avoid watering down the QM rule further.
Overall, the rule is a very significant step toward rebuilding the nation’s mortgage market. During the worst days of the housing bubble, mortgage lenders routinely peddled subprime loans to borrowers that were either unaware or misinformed of the underlying risk, giving them little to no chance of paying the loan back in full. Starting today, that era is over.