There is an old idiom that one shouldn’t lock the barn door after the horse has bolted. And it certainly applies to the recently released Consumer Finance Protection Bureau regulations designed to protect consumers from so-called “predatory lending” practices.
That’s because several of the law’s provisions are practices that lenders stopped long ago and aren’t likely to re-implement anytime soon.
This new law, which goes into effect in January 2014, makes changes and actually provides some substance to the skeletal structure of the Dodd-Frank Act, which stated that a lender had to ensure the consumer could repay their mortgage loan. (In other words, if the consumer defaulted on a loan, the lender could actually be held liable.)
The CFPB has now proposed that lenders, to protect themselves from possible litigation, must make only “qualified mortgages” — a type of mortgage that must meet the following conditions:
- No upfront fees or points in excess of 3% of the loan.
- The loan cannot exceed 30 years in term length.
- No interest-only periods or interest-only loans.
- No more “No doc” loans, in which the borrower does not have to prove their income.
- No negative amortization loans (the loan payment for any period is less than the interest charged over that period so that the outstanding balance of the loan increases).
- Restricts balloon principal payments and pre-payment penalties in most cases.
- Debt-to-income ratios for borrowers must be equal to or less than 43%.
- The loan must be a prime loan (interest rate must be close to the national average prime mortgage rate).
- The loan is eligible to be sold to Fannie Mae or Freddie Mac.
In addition, lenders are now required to perform eight tasks regarding the borrower’s ability to pay, and verify all of this with information from independent third-party sources.
Lastly, lenders can receive “safe harbor” status on qualified mortgages from potential legal action by borrowers by following the principles of the qualified mortgage parameters, as well as doing all of the following:
- Checking the borrower’s ability to repay the loan
- Checking the borrower’s income
- Not putting the borrower into a “bad” loan
- Disclosing to the consumer that they must re-pay the loan
This is nothing new, and lenders routinely do these things anyway, which points out the absurdity of the term “safe harbor.”
However, qualified loans still can be made without the “safe harbor” rules, which opens the door to borrowers who can’t repay their loan to sue the lender — by questioning whether the lender properly assessed the borrower’s ability to pay. Moreover, if the borrower defaults on a “safe harbor” QM, consumers still can legally challenge the lender if they believe that the loan does not meet the definition of a “qualified mortgage.”
CFPB Director Richard Cordray even said the term “safe harbor” was a mirage when he testified before Congress a few months ago. He was right.
How Real Estate Will React
Fred Wilkinson — president of Bankers Home Mortgage, in Jacksonville, Fla. — told me the new CFPB law can’t help the real estate market because it will keep a lid on lending, and doesn’t allow the mortgage market to create what it considers to be a good loan. In other words, it puts handcuffs on the free market to be able to make its own choice about what should constitute a worthy borrower.
Wilkinson did, however, point out that it is difficult to find the middle ground between an excessively regulated environment (in which real estate markets lag because lenders are unable to approve enough borrowers), versus one with no regulations — a la 2006, when the markets gave free rein to giving mortgages to less than worthy borrowers.
He also added that the CFPB’s ban on “teaser rates” (very low interest rates that increase to much higher rates after a short period of time, such as one year) might not affect the industry much in our present low-interest-rate environment, but will severely impact real estate sales if rates rise over the next few years.
The new CFPB law is effectively an empty shell, mandating lenders to do what they are already doing, prohibiting them from doing what they ceased doing long ago, and providing them with a false sense of security that if they follow the rules they will never be sued.
The only saving grace for the real estate industry is at least now there is some clarification of the changes that Dodd-Frank promised to bring — that is until some silly lawsuit brings about a whole new set of regulations designed to help the consumer (but which will have the opposite effect).
And how will this play out for homebuilders — many of whom are now doing their own mortgage lending? Only time will tell.