The New Future of Mortgages: An Explainer

There are two parts of the new rule (PDF). The first part isn’t very controversial and applies to all mortgages. It requires lenders to evaluate whether a borrower will be able to repay a loan. What a novel idea, right? Well, this wasn’t the law before in most cases. Under the new rules, the CFPB says lenders must consider at least eight specific criteria, including a borrower’s income, assets, credit history, debt obligations, and employment status. Lenders must verify and document this information—so no more “no doc” loans. The CFPB just tells lenders what to look at, not how to evaluate if the borrower has the ability to repay. That’s up to the lender’s judgment.

The second part of the law creates a new category called a “qualified mortgage.” Remember that phrase—you can expect to hear a lot more about it because it’s likely to become the new standard mortgage in the country. To be considered “qualified,” mortgages must follow specific product and underwriting criteria. They can’t have some of the features that proved to be disastrous in the housing bubble: terms longer than 30 years, structures where the principal balance increases (aka negatively amortizing loans), balloon payments, and fees and points that cost more than 3 percent of the loan. On the underwriting side, the most important new factor is that the borrower can’t have a debt-to-income ratio above 43 percent, meaning they can’t spend more than 43 percent of their monthly income paying debts, including mortgages, credit cards, and child support.

Here’s where the legal part kicks in. If a lender follows these criteria when lending at the prime interest rate, they will have strong protection from many lawsuits by consumers. The lender gets the benefit of the doubt that it properly assessed the ability of the borrower to repay, so a borrower will only be able to challenge whether the loan was truly “qualified.” If the loan has a subprime interest rate, consumers will have more legal options. A borrower will be able to say that even though the loan fit the “qualified” terms, the lender should have nonetheless determined that the borrower couldn’t really afford the loan. The bureau made this distinction because it says subprime borrowers tend to be more vulnerable to unscrupulous lending, a senior CFPB official said on a background conference call with reporters.

To make things even more confusing, because these changes are so massive and come at a time when the mortgage market is still fragile, the bureau is building in a transition period. During this period—which will phase out over seven years—loans will be considered “qualified” if they follow the standards set by Fannie Mae (FNMA), Freddie Mac (FMCC), or other government housing agencies, even if those standards differ from the CFPB’s.

Alys Cohen, a staff attorney at the National Consumer Law Center, said in a statement that the qualified mortgage rule “invites abusive lending and erodes the progress made by Dodd-Frank.” She said the legal safe harbor for prime qualified mortgages provides “absolute shelter” for reckless lenders and that the 43 percent debt-to-income ratio was too high for lower-income borrowers. The Center for Responsible Lending generally praised the rules, calling them a “reasonable approach to mortgage lending—for the most part.” In a statement, CFPB Director Richard Cordray said that “no standard is perfect, but this standard draws a clear line that will provide a real measure of protection to borrowers and increased certainty to the mortgage market.”

The bulk of the new rule is final and set to go into effect in January 2014. The bureau has walked back from a finalized rule before, but that’s unusual for regulators, particularly for regulations of this magnitude. In the coming weeks and months, the bureau plans to unveil other mortgage regulations, including standards for servicing loans, compensation for loan officers, and a simplified disclosure form. A whole new mortgage world is coming soon.