In the early and mid-2000s, mortgage lenders were handing out loans without the notion that they would ever be successfully paid in full. This, along with other factors, created the mortgage crisis that followed. In response to the crisis, Congress passed the Dodd-Frank Wall Street Reform and Consumer Protection Act. This act allowed the Consumer Financial Protection Bureau (CFPB) to implement new rules to protect consumers who are borrowing money to purchase a home. One of those rules was the Ability to Repay requirement for closed-end residential mortgage loans.
Standards of the Ability to Repay Rule
The CFPB instituted a rule on January 10, 2014 requiring lenders to review the borrower’s financial history to ensure that he or she can repay the loan before approving a mortgage application. The rule developed eight minimum standards for a borrower’s ability to repay. This information allows the lender to make a good-faith determination that the person seeking the loan does indeed have a reasonable ability to repay it.
- Current and expected income or assets that the borrower will use to repay the loan
- Current employment status and income, which must be verified
- Mortgage loan payment amount
- Payments due on other loans secured by the same property (i.e. second mortgage)
- Expenses related to the mortgage or the property (i.e. property taxes, HOA dues, insurance)
- Other debt obligations
- Monthly debt-to-income ratio or residual income
- Lender’s credit history, which must be verified
Ability to Repay Rule Exceptions
There are sometimes exceptions to the Ability to Repay rule. For example, if the borrower is refinancing from a loan that is considered risky, like an interest-only loan. This allows lenders to help those who have loans that are not sustainable. Additional exceptions include home equity lines, timeshare plans, reverse mortgages, bridge loans, a construction loan of 12 months, and transactions secured by a vacant lot.
Qualified Mortgages Comply with Ability to Repay
The rule assumes that a lender who offers a Qualified Mortgage has met the requirements. A Qualified Mortgage is considered standard and cannot feature interest-only payments, negative amortization, balloon payments, or a term longer than 30 years.
The Ability to Repay rule was set in place to remedy the market of risky loans that led to so many foreclosures over a decade ago. It does make it a longer and more complex process to qualify for a home loan, but the intention of the rule is to ensure protection for both the borrower and lender.