Back in mid-January, the Consumer Financial Protection Bureau (CFPB) proposed an amendment to the so-called “Regulation Z” of the Truth in Lending Act (TILA). The amendment will further enforce the rule currently in place, which prohibits lenders from selling a higher-priced mortgage loan without regard to to the borrower’s ability to repay. Although the new rule will not go into effect until next year, consumers who are considering taking out a mortgage loan in the future should be aware of the changes.
For banks, the Regulation Z/TILA made it a lot tougher to engage in lax lending practices, which contributed to the recent housing crisis. For consumers, the regulation meant stricter qualifying requirements. With the new amendment, these requirements are still in place, but lenders will have to follow more specific guidelines for determining a borrower’s financial risk.
In simplest terms, the new rule will protect lenders from risk, but will also make it a little tougher to generate new mortgage activity. Here’s a brief explanation of the major components of the amendment:
1. The rule will implement sections 1411 and 1412 of the Dodd-Frank Wall Street Reform Act (commonly called the Dodd-Frank Act), which generally require creditors to make a reasonable, good faith determination of a consumer???s ability to repay any consumer credit transaction secured by a dwelling (excluding an open-end credit plan, timeshare plan, reverse mortgage, or temporary loan) and establishes certain protections from liability under this requirement for ???qualified mortgages.??? A qualified mortgage (QM) is a mortgage that has been designated as lower risk becuase the lender has presumably investigated the borrower’s financial standing in detail.
2. The rule also implements section 1414 of the Dodd-Frank Act, which puts limitations on prepayment penalties. Some mortgages penalize borrowers for making higher mortgage payments, which is something many consumers are not aware of until it’s too late. If you’re unsure about whether or not your mortgage has prepayment penalties, you should contact your lender.
3. Finally, the amendment will requires creditors to retain evidence of compliance with the rule for three years after a covered loan is consummated. This part affects lenders more than consumers, as it requires them to prove that they have issued a mortgage under the necessary regulations. Nevertheless, it’s good for consumers to be aware that their banks are responsible for documenting their lending practices.
If you’re planning on buying a home in the next few years, you should know that this amendment will affect the process by which your lender issues mortgages. The biggest affect this could have on consumers is that it will require more documentation. Mortgage applicants should be prepared to show proof of employment, income and good credit history.
According to an information packet from the CFPB, lenders will generally investigate eight major financial factors when deciding whether or not to approve a mortgage loan:
- Your current income or assets (be prepared to show most recent tax documents)
- Your current employment status (be prepared to show recent pay stubs)
- Your credit history (make sure your credit is in good standing before you apply for a mortgage)
- The monthly payment for the mortgage
- Your monthly payments on other mortgage loans you get at the same time (piggy-back loans)
- Your monthly payments for other mortgage-related expenses (property taxes, PMI, etc.)
- Your other debts (credit card balances, auto loans, student loans, etc.)
- Your monthly debt-to-income ratio (how much money you owe to various creditors each month vs. how much money you earn)
In addition to these financial indicators, your lender must calculate your ability to repay based on the highest possible interest rate for the mortgage program in question. In other words, if you are applying for a 3 year Adjustable Rate Mortgage (ARM), you will have a set interest rate for the first three years of the loan. After the three-year period is up, your interest rate may go up. Adjustable rate mortgages have interest rate caps, which prohibit the rate from increasing beyond a certain point. Under the new rule, lenders will have to calculate your ability to repay based on the highest possible rate for the ARM, not the initial rate.
There are exceptions to the new rule when it comes to refinancing. There are certain circumstances in which a lender can determine that it is less risky to refinance a borrower. In these instances, the Ability-to-Repay rule may not apply. For example, if you have an interest-only loan and you want to refinance to a traditional 30 year fixed rate loan, your lender may not need to follow all of the documentation and financial investigation regulations set forth by the rule.
For more information, please read the CFPB’s summary packet here: http://files.consumerfinance.gov/f/201301_cfpb_ability-to-repay-rule_what-it-means-for-consumers.pdf