The Consumer Financial Protection Bureau (CFPB) has been promising changes in the way mortgages are written in this country and as promised, it’s now delivered what it refers to as the Ability to Repay Rule. The goal was simple: to ensure a level of common sense was built into borrowing and lending guidelines. Before coming up with the meat and potatoes of this rule, it sought consumer input. For more than a year, it collected that input and gave all of those recommendations proper consideration.
Stated Loan Programs
Many may recall the stated loan programs that were popular right up until the mortgage crisis kicked in. Stated programs allowed applicants to simply state their income, employment and assets with no verification efforts on the part of the loan officers nor the lenders. It was, simply stated, bad business and played a significant role in the mortgage meltdown which had kicked in a year before the recession. There’s no shortage of blame to go around; some say consumers hold the lion’s share of responsibility for entering into contracts they knew they would not be able to honor. Others blame the industry for the same reasons and say the failure to better serve their customers shows the level of greed in the industry.
As a result of those failed stated programs, lenders are now required to check, double check and then check again the information on mortgage applications. They must verify a potential homeowner’s income, assets and even previous employment. Tax filings and other documentation that at one time was always required, but fell to the wayside in recent years, is once again required paperwork that must be included in the decision making process. The purpose is to ensure the consumers can repay their loans. The better vetted the consumers are, the better the odds of a successful contract – and the less likelihood that lenders find themselves in hot water.
Fast and Loose
At a hearing last week, CFPB Director Richard Cordray said that many borrowers and their loan officers played fast and loose with the numbers to get the loans approved. He referred to it as “reckless lending” and said that it was an “endemic problem”. He then reiterated his faith in the new rules, saying,
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.
He said that consumers were “led astray”. Whether or not they were is moot at this point; the fact is, the record number of foreclosures are a reality and the repercussions will continue for years.
The dynamics all came together at the same time to define what ultimately became a financial catastrophe. That said, the entire crisis could have all been avoided had there been better safety nets in place that were actually being used. Unfortunately, people with salaries of $40,000 were being approved for half million dollar mortgages. There was no way they could sustain those kinds of monthly payments – even if they’d received hefty raises in the early years of their mortgage. The fact that property values were consistently on the rise didn’t help matters, either. Insurance costs and other considerations only added fuel to the fire.
Failure to Comply
Failure to comply with these new requirements have big repercussions and in fact, it could serve as an argument by homeowners facing foreclosure, but who are doing everything they can to prevent that. This will only further enhance efforts by lenders to ensure the loans they make going forward have great odds of successfully being paid. The question is: is it possible that the lenders may swing too far the other way by making the stipulations so unreasonable that only a percentage of applications are actually worth of approval? It’s a legitimate concern and one many analysts say could wreak even more havoc.
The new criteria prohibits risky decisions and practices. In fact, a loan can’t be deemed qualified unless the consumer’s debt to income ratios, or DTI, of 43 percent or less. It should be noted, too that the CFPB has extended a brief reprise in this rule.
For loan officers, points and fees are restricted, too. For instance, the threshold on a $100,000 mortgage is limited to just 3% of the loan in terms of how much the loan originators can make. This all but eliminates potential yield spread bonuses, too. For now, banks and loan officers are closely examining various loan dynamics to ascertain how the numbers break down. There’s still some time, however; the new rules don’t go into effect for another year. The different fees that brokers and officers can claim is still being debated, so that could change in the coming months.
Under the new Ability to Repay rule, the points and fees will include all compensation that’s paid to a loan officer by a consumer via the contractual terms of the mortgage. That could prove problematic considering the way these fees are calculated. How will the different fee dynamics shift if some are based on the total contract before other costs are calculated and others are determined after those additional monies are applied? There’s still much to work out before the law kicks into gear, especially considering this has become a sticking point. The CFPB recognizes this.
The government agency is still trying to work those details out via requests for public input. Cordray has expressed the agency’s collective beliefs that Congress intended the Dodd Frank law to require lenders to view loan officer compensation as “additive”. CFPB remains unsure, saying, any automatic literal reading of the laws “would be in the best interest of either consumers or industry…” For instance, CFPB does not believe that it is should be required – not to mention that it’s inappropriate – to count the same payment between a consumer and a mortgage broker firm twice.
And of course, the controversy is just beginning. Before the agency issued its final rules on this particular sector, there were those who believe loan originator compensation shouldn’t be grouped together, partly because of concerns over double counting.
Remember, too, that with recent changes in the tax laws, it’s going to be more difficult for consumers to even buy a home. How it all comes together remains to be seen, but there’s one certainty: the rules have changed and not a moment too soon.