TOPICS > Economy

New Mortgage Lending Regulations Require Proof of Borrower’s Ability to Repay

January 10, 2013 at 12:00 AM EDT
A new set of federal guidelines on mortgage lending has been released in efforts to protect banks and potential homeowners from the risky practices that caused the 2008 housing crisis and economic collapse. Margaret Warner talks to Richard Cordray, director of the recently-established Consumer Financial Protection Bureau.

JEFFREY BROWN:  Next: new mortgage rules from the government designed to clamp down on risky lending practices. 

Margaret Warner has the story. 

MARGARET WARNER:  At the root of the 2008 credit and housing bust were risky, even reckless mortgages made to customers who couldn’t afford them. 

Today, the new Consumer Financial Protection Bureau issued regulations spelling out how lenders must ensure that borrowers can repay their loans.  Banks that follow the criteria would be protected from most lawsuits.  To meet the standard of a qualified mortgage, a bank would have to verify the borrower’s income, employment and total debt, which could not be more than 43 percent of his or her income. 

The criteria also would prohibit subprime loans, teaser low-rate mortgages with balloon payments later, interest-only mortgages, and fees of more than 3 percent.

Richard Cordray is the director of the agency, and he joins me now. 

Mr. Cordray, welcome.  Thank you for joining us. 

RICHARD CORDRAY, Director, Consumer Financial Protection Bureau:  My pleasure. 

MARGARET WARNER:  Now, banks and mortgage lenders have already very much tightened their lending standards.  Why are such specific regulations needed now? 

RICHARD CORDRAY:  Well, if you go back and you remember how we came upon the financial crisis, it happened because of tremendous amounts of reckless lending in the mortgage market. 

You had many loans where consumers were set up to fail.  There wasn’t careful attention to whether a borrower could repay a loan.  That got us into trouble.  It sank the economy.  And we want to make sure that that doesn’t happen again. 

MARGARET WARNER:  And so to what degree do you think these specific criteria you all have set up would get to the root, the heart of what led to the bubble and the bust?  In other words, how many of the sort of abuses do you think you’re covering here or preventing here? 

RICHARD CORDRAY:  So we’re taking on some of the very specific problems that we know helped create the financial crisis, first of all, no-doc loans, where the lender didn’t even pay attention or ask for any documentation from the borrower. 

We had what were called ninja loans, no income, no job, no assets, and yet borrowers still could manage to get loans approved.  We had loans where introductory teaser rates were treated as the rate that would last through the entirety of the loan.  And so they were underwritten not against the real price of the loan, but against some artificial introductory rate. 

Those were loans that ended up setting up many consumers to fail, and they were at the heart of the reckless lending that helped precipitate the crash in the housing market. 

MARGARET WARNER:  Let me ask you about the 43 percent debt-to-income ratio.  That debt includes, say, student loans, credit card loans.  How many borrowers will be shut out of being able to afford a mortgage for a house they’d want because of that total debt limit?

RICHARD CORDRAY:  So there’s a couple things that we have done here. 

First of all, we have set a debt-to-income ratio for a qualified mortgage, which is a subset of mortgages within the ability-to-pay rule that get the maximum protections for consumers.  That’s a more generous level than typical underwriting had been.  It used to be quoted around 33 or 36 percent of income. 

We have also included a temporary provision that takes account of the fact that we have Fannie Mae and Freddie Mac undergirding most of the market now, and we’re going to allow for a transition as Congress and others consider how to reform those entities. 

MARGARET WARNER:  But, I mean, have you been able to quantify how many people today are getting mortgages, though their total debt — I’m thinking particularly student debt, which didn’t used to be a huge factor, but is for a lot of young people now — how many people are right now getting mortgages for that, say, with 50 percent total debt that just will be shut out now?

RICHARD CORDRAY:  So, giving the two pieces of the criteria that I described, not only the 43 debt-to-income ratio, but the other provision, we have crunched the numbers, and it appears that virtually all of the existing mortgage market would be covered by this rule. 

So we don’t think that we’re going to be crimping lending, and we don’t mean to be and don’t want to be crimping lending.  We have drawn the rule carefully to avoid that. 

In addition, what I think you will find is, with stronger consumer protections and clearer rules of the road, that’s good for lenders, because, first of all, they have more certainty.  They should be able to get more secondary market financing going to support their lending. 

Secondly, they don’t have to compete anymore against the reckless lending that really undercut them in the market, often misled consumers into taking out bad loans, when they could have gotten responsible loans.  That’s no longer going to be the case in this market, and that’s good for everybody. 

MARGARET WARNER:  So, do you think, on balance, say in the short to medium term, this will further restrict lending?  A lot of people are complaining now it’s very hard to get a mortgage.  Or do you think it will actually boost it? 

RICHARD CORDRAY:  I actually think this is going to boost lending, because, as I said, it is going to provide more certainty for the market.  Many people were watching to see what this rule would provide. 

We are providing a potential exemption, and it’s a proposal to take account of community banks and credit unions and give them more leeway to make the kind of loans that they make in small communities across this country.  We’re looking at an exemption for nonprofits, such as Habitat for Humanity and others.

And I think, in the end, we are going to have a robust portfolio of mortgage financing.  And we want to see this housing market recover.  And this rule is a step in the right direction. 

MARGARET WARNER:  Now, how tight or how complete is this safe harbor that you’re offering to banks, that is, protection from lawsuits, if they issue a qualified loan, vs. one — I guess they’re still going to be able to issue loans that don’t meet this criteria. 

RICHARD CORDRAY:  That’s correct. 

The safe harbor, what this has to do with is the extent of liability a lender can incur.  The bottom line here is consumers can always still have their day in court.  They can enforce all the other consumer protection laws that aren’t affected by today’s rule.  And if it’s a qualified mortgage, they can still go to court and challenge whether those criteria were met. 

They’re fairly bright-line criteria, so I wouldn’t expect a lot of challenges.  But consumers have that available to them.  In the more risky subprime space, which was really the cause of the crisis, consumers can also go to court and challenge whether they had the ability to repay and the lender paid appropriate attention to that. 

MARGARET WARNER:  But the lending, the mortgage industry generally was supportive today after you issued these rules.  There must be something they like about it. 

RICHARD CORDRAY:  I think what they like is, there’s certainty here. 

We have tried to draw bright lines and not leave a lot of things fuzzy that will end up having to go into the courts and be resolved over many years.  I think people were waiting for this rule.  And I think we have drawn the circle of qualified mortgages quite broadly, so as not to cramp lending in the mortgage market. 

So, I think, on balance, this is a good direction for lenders.  I think it’s good for consumers. They can now have confidence that the lender has to check on the numbers and make sure they check out.  That’s fairly commonsense, but it wasn’t something that was present in the mortgage market in the go-go years.  And consumers can have confidence, they go to the closing table, they’re not being set up to fail. 

MARGARET WARNER:  Well, Richard Cordray, head of the Consumer Financial Protection Bureau, thank you. 

RICHARD CORDRAY:  My pleasure.