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The new Consumer Financial Protection Bureau is off to a good start. Its first major act is a set of new rules to be followed by banks when making mortgage loans. The rules not only protect the borrowers, but give the banks some “safe harbors” that will, hopefully, allow them to make more mortgages with less red tape.
The goal is twofold: to protect borrowers and to encourage lenders. One of the reasons the housing market has had difficulty in rebounding is the difficulty of getting a new loan, as well as refinancing an existing loan. The banks have been running scared — demanding reams of paperwork and huge down payments before they will make a loan.
We all know that many mortgage brokers, banks and investment banks made mortgage loans in the last decade that were designed to earn fees — not to help homebuyers get started on the track toward long-term homeownership. The new rules are designed to make sure that consumers take out mortgages only that they are likely to afford.
At the same time, banks that make loans under these new guidelines can avoid liability for the loans if the consumer loses a job and cannot repay this new, “qualified” mortgage. That should encourage banks to start lending again — to qualified buyers — with more reasonable procedures.
The new mortgage rules go into effect next year. Technically, this change falls under Dodd-Frank, which gave oversight responsibility for mortgages to the Consumer Financial Protection Bureau. Now, the CFPB has spelled out specifically what kinds of mortgages will give lenders the protection against liability.
There are two basic tests a borrower must meet to verify that the bank is making a qualified loan:
— The borrowers’ total debt payments cannot be greater than 43 percent of their pre-tax income.
— Or the loan must be approved only after being approved by the automated underwriting programs of Fannie Mae, Freddie Mac or the FHA — even if the loan is not subsequently purchased or guaranteed by one of those agencies.
The idea is that if the loan is considered “sound” under one of these two principles, there will be less chance of loan defaults.
This type of loan will encompass the vast majority of mortgages that are currently being made. According to the CFPB, nearly 75 percent of all loans made in 2011 met the first standard. And beyond that, about 20 percent of the loans that were above the 43 percent standard also met the second criteria.
But many of the popular loans of a decade ago will not ever be considered qualified. For example, if you have an adjustable rate loan, you cannot qualify based on the initial low monthly payment required to get the loan. Instead, you would have to qualify based on the highest payment that could apply during the first five years of the loan.
No loan that increases the principal balance will be considered qualified. And interest-only loans will not qualify. Also not qualified are “jumbo” loans — those over the FHA ceilings of $417,00 nationally, and as high as $729,750 in some higher-income areas.
Additionally, a mortgage will have a 3 percent cap on fees and origination costs charged by lenders. This will impact many homebuilders’ deals that include financing from affiliated companies and are likely to be above the qualified limit.
In other words, the mortgage business will revert back to its historical standards, becoming far more conservative. The rules do not actually require a minimum down payment to make the loan qualify under these standards. The focus is on affordability. Thus, a mortgage application will be approved based on past income, and current employment.
The protection for the banks is simple: If the loan meets these standards at the time it is made, the bank is legally protected against the kind of fraudulent charges that have resulted in nearly $100 billion in settlements and penalties for major banks in the past year.
This isn’t a blanket protection against lawsuits. The CFPB also said it would give the highest level of protection to loans that have a rate set at the prime rate when the mortgage is made — or set within 1.5 percentage points of the national average of mortgage rates.
Lenders can still make loans that aren’t considered “qualified” — but they will be far more risky and more heavily impact banks’ balance sheets. So the vast majority of new loans will be made under the new, “qualified” rules.
Will this new set of rules unlock the market to homeownership? Only time will tell — and the clock doesn’t start running until next year, although some lenders will immediately adopt the new standards to give them protection on the loans currently being made. There will still be tough underwriting standards based on income. But these new protections for lenders might encourage them to take some of the money sitting on the sidelines and put it to work making good, qualified mortgages.
That would be a good thing for the entire economy. And that’s The Savage Truth.