For months lenders have been worried about new lending rules, so-called “ability to repay” guidelines which might expose them to expansive liability from dissatisfied borrowers. Now the new rules are here and lenders can relax — mostly.
Under the Dodd-Frank Wall Street Reform and Consumer Protection Act lenders can make two kinds of home loans: First, there are “qualified mortgages” or QM loans within a “safe harbor” created by the legislation which makes “ability to repay” claims from borrowers virtually impossible. Second, lenders can make loans outside the safe harbor, loans where potential lender liability has now been relaxed but not eliminated.
This sounds like pretty dull stuff until it’s related to profits, dollars and lawsuits — hundreds of billions of dollars in potential profits and legal awards will be influenced by the new rules.
In the past year the big banks have paid out billions of dollars in claims because of allegedly-faulty mortgages and loan practices. Just last week there was an $8.5 billion settlement between regulators and 10 major servicers — and that wasn’t even the biggest settlement of the week, a deal worth as much as $11.6 billion between the Bank of America and Fannie Mae.
While the big players such as mortgage investors and insurance plans get their day in court with great regularity what you rarely see are suits made directly by borrowers. Mounting a claim against a big bank with massive resources is no easy task, but under Dodd-Frank the path for homeowners could be much easier — depending on what the final rules say.
One of a series of final rules has now been issued by the Consumer Financial Protection Bureau. The so-called “ability to repay” guidelines limit lender liability to just about zero when they make qualified mortgages within the safe harbor. Such QM loans include FHA, VA and conventional mortgages that are underwritten with full-doc loan applications and require points and fees that do not exceed 3 percent of the loan amount.
Outside The Safe Harbor
What about loans outside the safe harbor? The CFPB could have said that such mortgages were inherently foul and given a green light to a variety of legal claims but it didn’t. Instead it created “a rebuttable presumption for subprime loans and defines with more particularity the grounds for rebutting the presumption.”
Translation: Lenders will be able to make loans outside the safe harbor but the days of wild-west lending are over. Implausible teaser rates, no-doc mortgage applications and toxic loans with a high probability of failure open the lender to borrower claims.
There’s a lot of balance to the CFPB decision. We want a lending system that can change as financing ideas evolve and we want some flexibility in the qualification process because not every borrower is a letter-perfect applicant. At the same time, not too many lenders — or mortgage investors — will want to fool with loans outside the safe harbor because borrowers now have more rights than in the past and the legal shield for lenders that has long been assumed with high-risk mortgages is today less formidable.