published Wednesday, January 16th, 2013

Personal Finance: New mortgage rules provide haven for banks

By Chris Hopkins

At last, after 4,000 years of banking history, the government has imposed standards for safe mortgage lending practices in the form of the Ability-to-Repay rule.

This new regulation, promulgated by the Consumer Financial Protection Bureau, introduces a list of requirements lenders must satisfy in order to make sensible mortgage loans to consumers.

If they do so, the lenders are sheltered from legal liability if the borrower subsequently defaults.

Development of the new rule for mortgage loans was stipulated in the Dodd Frank financial reform legislation. The agency responsible, the CPFC, was also an offspring of Dodd Frank.

In the aftermath of the subprime mortgage crisis, regulators felt compelled to implement new rules aimed at avoiding a repeat of the 2008 debacle.

The rule creates a class of mortgage loans called "qualified mortgages," which meet certain standards of evaluation.

Mortgage originators must now consider, at a minimum, eight specific factors before underwriting a new home loan. The astute reader might guess a few of these qualifying factors, but here is a sampling: current income, employment status, monthly loan payment, other debt obligations, debt-to-income ratio, and, last but not least, credit history.

Furthermore, qualified mortgages may not include negative amortization, interest-only payments, balloon payments or terms exceeding 30 years, with points and origination fees not to exceed 3 percent of the loan.

Satisfying the underwriting standards allows the lender to certify the loan as a qualified mortgage and take advantage of a "safe-harbor" provision that protects the lender from litigation later on if the borrower cannot make the payments.

The new rule does not prohibit banks from making mortgage loans that do not meet the definition of a qualified mortgage, subject to the age-old relationship between risk and return.

Essentially, the Ability-to-Repay rule defines the boundary between prime and subprime loans. Subprime loans may still be underwritten, but the lender bears the risk in the event of default (see first paragraph; lenders have been in this business since the advent of commerce).

Perhaps the richest irony attending this government-imposed, rules-based approach to eliminating risk is that it ignores one of the most prominent causes of the original crisis: government.

Fannie Mae and Freddie Mac were encouraged (nay mandated) to expand mortgage lending beyond any reasonable expectation of repayment.

The mortgage market in the United States now is so thoroughly dysfunctional that nearly 90 percent of all home loans are issued or held by Fannie and Freddie. These naughty miscreants are now wards of the taxpayer, to the tune of $150 billion in bailout costs (about equal to the AIG rescue, all of which has now been repaid).

In trumpeting this victory for the common man, the CFPB website introduces us to Henry from California, who signed a $500,000 mortgage loan on an annual income of $50,000. Under the new rule, Henry would be counseled that a monthly payment exceeding 90 percent of his take-home pay might be a bit of a stretch.

Get answers to financial questions on Wednesdays from our columnists who work in the financial services industry. Christopher A. Hopkins CFA, is a vice president at Barnett & Co. Submit questions to his attention by writing to Business Editor Dave Flessner, Chattanooga Times Free Press, P.O. Box 1447, Chattanooga, TN 37401-1447, or by emailing him at dflessner@timesfreepress.com.

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