Ability-to-Repay Rule for Mortgages Nears CFPB Approval
Richard Cordray wants lenders to adhere to the most basic tenet of banking: making sure borrowers can repay. Getting them to agree on how is proving tougher.
The director of the Consumer Financial Protection Bureau is aiming to discourage lenders from making home loans with risky features and outlining steps they must take to verify borrowers’ finances, as part of the “qualified mortgage” or QM regulation. Banks that follow the guidelines will gain legal protection against borrower defaults.
“Here’s what should be the least surprising lending advice you’ve ever heard: If you are going to lend money, you should probably care about getting paid back,” Raj Date, the agency’s deputy director, said in a speech April 20 in Los Angeles.
The rule, which may be released as soon as next month, is dividing the banking industry with the largest mortgage firms such as Wells Fargo & Co. and Bank of America Corp. siding with some consumer groups that the provision should allow certain lawsuits. Trade groups whose members include smaller lenders are holding out for a version that would protect bankers entirely from being sued, arguing that without the provision, home loans will be costlier and harder to obtain.
The big banks consented to a weaker standard of legal protection in exchange for a broad definition of the types of permissible mortgages in the new rule, according to a March 7 letter to Cordray from the Clearing House Association, which represents the largest lenders. This step would “combine prudent lending with less litigation, benefiting homeowners, investors and lenders alike,” according to the letter.
To obtain legal protection, a lender would have to meet underwriting standards such as verifying a borrower’s income and assets. Qualifying loans also couldn’t have features such as interest-only payments or include fees and points totaling more than 3 percent of the loan amount.
Cordray has called the regulation, required by the 2010 Dodd-Frank Act “one of our most important rulemakings,” four years after home loans triggered the worst financial crisis since the Great Depression. It’s part of a broad overhaul of housing finance by multiple federal agencies, that will eventually include legislation overseeing mortgage servicing, securitization and restructuring the government role.
After the release of the qualified mortgage rule, regulators say they will work on legislation requiring lenders keep a stake in some securitized mortgages, known as the “qualified residential mortgage” regulation.
Mortgage originations in the first quarter rose 5.3 percent to $318 billion from the same period last year, according to Mortgage Bankers Association estimates, as homeowners took advantage of mortgage rates near record lows to refinance. Volumes are down from $729 billion in the quarter ending June 2006, a month before home prices in the U.S. peaked on their way to a 35 percent decline.
Once the rule goes into effect, lenders are expected to originate most of their loans according to the new standards in order to gain legal protection from the kind of lawsuits and “putbacks” that have cost banks billions in the wake of the mortgage crisis. The additional legal protections will help banks compensate for lost revenue from higher fees or exotic loans such as interest-only mortgages.
In the years leading up to the financial crisis, banks increasingly made loans with high fees and adjustable terms that borrowers wouldn’t be able to repay, requiring them to refinance after a few years. When housing prices dropped, many defaulted instead.
“This rule is aimed directly at the core deficiencies in the mortgage market that produced unsustainable loans, an inflated housing market, and resulting widespread economic hardship,” Americans for Financial Reform, a coalition of consumer advocacy groups, wrote Cordray in an April 18 letter.
Consumer groups are pushing to prevent the rule from providing total protection for lenders. They want to ensure homeowners or bond investors would still be able to sue banks if they could prove lenders didn’t act in good faith when issuing mortgages.
The rule could influence the volume and profitability of mortgage lending, particularly to lower-income borrowers. Bank of America (BAC) said in a comment letter that the rule could reduce its mortgage lending, which totaled $298 billion in 2010 and included $70 billion to low- and moderate-income households.
In recent months, the banking industry has split on the issue of protection against lawsuits. The Federal Reserve, which issued a first draft of the rule a year ago, said the Dodd-Frank Act left it unclear which approach to take.
The Fed proposal, which the bureau will finalize, included two alternatives. The first was complete protection from liability known as “safe harbor.” The other would provide less legal protection -- a “presumption” that loans issued according to quality standards were non-abusive -- that could nonetheless be rebutted by a borrower or bondholder in court.
The Clearing House Association filed a public comment with regulators on Dec. 7 on behalf of large banks that advocated the safe harbor. The association is the advocacy arm of The Clearing House, a banking association and payments company owned by the largest U.S. banks including JPMorgan Chase & Co. (JPM) and Wells Fargo. (WFC)
The Clearing House Association changed its stance after meeting with consumer groups. The association signed onto the March 7 letter to Cordray endorsing a version of the rebuttable presumption option, according to a copy of the letter. In addition to the Clearing House, signers included the Center for Responsible Lending and the Consumer Federation of America, two advocacy groups.
‘Not Casual Redress’
“It’s about ensuring that lenders have a strong incentive to fulfill all the obligations they’re required to fulfill,” Barry Zigas, director of housing policy for the federation, said in an interview. “The consumer who is disadvantaged does have redress, but it’s not a casual redress.”
The agreement among the consumer groups and a banking association who are usually on opposite sides has drawn criticism from smaller banks and from other borrower advocates.
In a March 12 letter, a collection of consumer groups that includes the National Consumer Law Center and the National Association of Consumer Advocates wrote that the legal hurdles homeowners would have to surmount to bring a case under the proposed compromise “is so onerous as to approach a safe harbor.”
Seeking Safe Harbor
Other banking associations that include some of the Clearing House’s members are still lobbying for complete liability protection. David Stevens, the president of the Mortgage Bankers Association, which represents large and small lenders, said that only a safe harbor can minimize the litigation risk. Otherwise, lenders will add a larger risk premium to loans.
“All that’s going to do is make loans for borrowers at the margin more expensive,” Stevens said in an interview.
“This uncertainty will make borrowing more expensive and credit less available,” Keating said in an e-mailed statement. “Some lenders may leave the market altogether.”
The Independent Community Bankers of America, an association of smaller institutions, is critical of the “Clearing House flip,” its president, Camden Fine, said in an interview. Fine’s group, whose members the consumer bureau has wooed extensively, wants a safe harbor.
“Big banks know they have the resources to fight any litigation that may come out of these regulations,” Fine said. “Community banks do not.”