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In the wake of the housing market meltdown, Congress passed the Dodd-Frank Act. It implements changes including the oversight and supervision of financial institutions, a resolution procedure for large financial companies, places more stringent capital requirements, and incorporates the Volcker Rule. One of its provisions created the Consumer Financial Protection Bureau (CFPB).
New rules will go into effect starting in January. Although passed in 2010, and the CFPB came into being in mid-2011, many of the provisions will kick in next month.
The new requirements do not seem to make the process more cumbersome. Some have argued it will be more difficult to get a mortgage, but if you meet the financial requirements, such as income and assets, this shouldn’t be an issue.
Nonetheless, borrowers should be aware of these changes in order to be prepared. The CFPB amended a regulation that requires creditors to make a good faith determination of a borrower’s ability to repay a loan secured by a dwelling (e.g. home mortgage or home equity loans/line of credit).
At a minimum, lenders are required to consider eight underwriting factors. These include income or assets, employment status, monthly payment on transaction, monthly payment if there is a simultaneous loan, monthly payment for mortgage-related obligations, current debt obligations, alimony, and child support, monthly debt-to-income ratio (cannot be more than 43% of pretax income), and credit history. The 43% requirement has drawn complaints from some in the lending community, but Shelia Bair, former chairperson of the FDIC stated many banks did not make loans if the payments were more than 35% of income, prior to the loosened lending standards in the bubble years.
There are other provisions, such as limiting prepayment penalties, and requiring creditors to retain evidence of compliance. One underwriting requirement not mentioned but is often included in a bank’s underwriting process is the loan-to-value, but providing the amount borrowed isn’t too large compared to the home’s value, this shouldn’t be an issue. There is also no requirement that a certain percentage be placed as a down payment.
The idea behind the rules are simple. In the years leading up to the crisis, lending standards became very lax, including loans without proper documentation and the failure to verify income. In addition, many borrowers were lured into mortgages with low initial rates that jumped after a period of time. In many cases, the homeowner hoped to refinance before then based on the home’s value rising. When that didn’t occur, the payments became unaffordable. This helped lead to the housing bubble, and the inevitable bursting that helped cause a serious recession.