It seems like a no-brainer: Only those who are able to repay mortgages should get them. Yet the housing market is still climbing out of a hole dug by lenders who thought otherwise.
Come Jan. 10, nearly seven years after the housing market crashed and burned, a rule designed to ensure mortgages are granted only to borrowers who can repay what they owe will take effect. Called the Ability to Repay/Qualified Mortgage Rule, the regulation was written by the Consumer Financial Protection Bureau in accordance with requirements of the Dodd-Frank Wall Street Reform and Consumer Protection Act.
Under the rule, mortgage lenders are required to verify ability to repay. The provisions apply to most mortgages but exclude certain types of loans, such as home-equity lines of credit, time-share plans, reverse mortgages, and temporary loans.
In addition, the rule says lenders may not use temporary low-payment or "teaser" rates to determine whether a borrower is able to repay.
If the loan is an adjustable-rate mortgage, the lender will generally have to consider the highest interest rate the borrower may have to pay.
The ability-to-repay rule also may not apply to a creditor refinancing a borrower from a riskier mortgage - an interest-only loan, for example - to a more stable one, such as a fixed-rate mortgage.
Created under the new regulation is a category of loans with certain more stable features - so-called qualified mortgages - and the lenders making them are presumed to have met the ability-to-repay requirements.
Mandatory features of a qualified mortgage include:
Points and fees that are less than or equal to 3 percent of the loan amount. For loan amounts less than $100,000, higher percentage thresholds are allowed.
No risky instruments, such as negative amortization, interest-only loans, or balloon loans. But balloon loans originated until Jan. 10, 2016, that meet the other product features will be considered qualified mortgages if they are originated and held in portfolio by small creditors - defined as those with less than $2 billion in assets and that originate 500 or fewer first mortgages each year.
A maximum loan term that is less than or equal to 30 years.
Qualified mortgages will generally require borrowers' monthly debt, including the mortgage, not to be more than 43 percent of monthly pretax income. This requirement has caused concern that many low- and moderate-income buyers will be shut out of the market. But the Federal Housing Administration, a huge source of mortgages, does not have a debt-to-income ratio, for example, nor does the requirement apply to small creditors.
Lenders making qualified mortgages get certain legal protections even if the borrowers default.
Still, lenders and mortgage brokers remain concerned about the rule, and some have appealed to the Consumer Financial Protection Bureau to delay it.
"I think the intentions are good, but, like a lot of things, may have unintended consequences," said Jerome Scarpello, president of Leo Mortgage in Ambler. "Like any new legislation, you may find some people that are hurt by it."
The "safe harbor" protections for lenders require debt-to-income ratios for borrowers not to exceed 43 percent.
"Recent studies have estimated that more than one in five mortgages today would not meet this requirement," Scarpello said.
For many borrowers, the effect "will be the inability to purchase or refinance their homes," he said. "This, in turn, could be a drag on the housing market, at a time when the economy is just starting to show signs of improvement."
Scarpello believes fewer loan applications will be approved.
"If a lender does not have the safe harbor of the qualified mortgage, why would they risk a 'buy-back' on a borrower with a back ratio of 44 percent?" he asked.
Philadelphia mortgage broker and Realtor Fred Glick said the rule would hurt "in many, many ways," adding that the 43 percent cap does not consider compensating factors or the size of the down payment.
The rule will spawn "companies doing nonqualified mortgage loans that will undoubtedly be [at] much higher interest rates, in other words, a return to legalized subprime mortgages with more down payment," Glick said.
"First-time-buyer programs will diminish as lenders will be scared off by overregulation," he said.
"If the first-time buyers stop buying, the move-up buyers can't," he added, resulting in a possible slowdown in the real estate market.