New rules limit risky mortgages

This post comes from Marilyn Lewis of MSN Money.

A set of new government rules issued by the Consumer Financial Protection Bureau requires lenders to make sure that borrowers can repay their mortgages.

The goal is "mortgages that consumers can actually afford to pay back. This is a simple, obvious principle that needs to be cemented in the housing market," said CFPB director Richard Cordray in a letter on the agency's website.

The new rules, required by the 2010 Dodd-Frank Act, should curtail widespread use of the risky mortgage types and features that contributed to the housing collapse. 

What will change

The rules won't take effect for another year, and will be phased in. 

They establish a category of "qualified mortgages" offering the most protections for consumers. These also protect lenders from the threat of lawsuits by borrowers and investors. Qualified mortgages impose stiff requirements on borrowers and lenders.

The rules also make it hard for banks to offer interest-only mortgages. Negative-amortizatio​n loans, where the balance owed grows larger with each payment rather than smaller, will be hard to get.

Lenders will have to document borrowers' ability to repay. That means far fewer "no-doc loans," in which borrowers don't need to show what they earn or the source of the income.

When selling an adjustable-rate mortgage, lenders will have to show that a borrower can afford not only the initial payments based on the low introductory rate, but also the higher payments charged when the rate is adjusted upward.

In practice, many of these features and loan types have been unavailable since the housing boom ended. In fact, lending is currently so tight that Realtors and shut-out borrowers complain that banks are too restrictive.

Protection from consumer lawsuits

To win lenders' cooperation, the rules offer both a stick and a carrot. The "stick" is the big list of requirements. The "carrot" is the promise of protection from lawsuits by borrowers in foreclosure. If lenders adhere to the rules, they'll be largely shielded from lawsuits by consumers.

"Banks can make such loans, but the new rules would not protect them from potential borrower lawsuits if they do so," says The New York Times. 

The Wall Street Journal writes:

"While the CFPB rules wouldn't necessarily have prevented banks from making exotic loans during the housing bubble, lenders would have faced far greater legal liability had the rules been in place because borrowers would have been able to sue for damages in a foreclosure. Mortgage-finance giants Fannie Mae and Freddie Mac also would have faced greater liability for buying such loans."

Upshot for consumers

For consumers, the rules promise more safety. But there are loopholes. Consumer advocate Alys Cohen, a staff attorney for the National Consumer Law Center, said in an email interview:

"There are gaps and loopholes . . . predictable ones and ones we don't yet know about. When those emerge, many homeowners will have no recourse (to sue) and banks will have full legal insulation under the rule, even for making some knowingly unaffordable loans.

Dean Baker, a co-director of the Center for Economic and Policy Research in Washington, D.C., said he's "pretty comfortable" with the new rules.

Reached by email, Baker said he was less troubled by loopholes. "At the end of the day, no regulations are worth anything if the regulators aren't doing their jobs."

The effect on cost and availability of mortgages isn't entirely clear. The Washington Post  predicts it will become harder for consumers to get qualified mortgages, but those who do will enjoy lower rates and fewer fees.

Borrowers who can't get a qualified mortgage have other avenues. Low- and moderate-income borrowers, for example, can try smaller lenders, such as community banks and credit unions. These lenders typically hold on to their mortgages rather than selling them to investors, as larger lenders do. This gives them more flexibility. But these loans entail more risk for lenders, so they're likely to be more expensive.

The Wall Street Journal predicts that the new rules will limit choice and variety of mortgages. "The upshot is that banks are likely to narrow their loan offerings and rely more on the 30-year, fixed-rate mortgage, a product unique to the U.S. and one that has required a government guarantee."

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