Mortgage Rules on "Ability to Repay"

The CFPB's ability to pay rule requires mortgage lenders to make sure a borrower can afford a mortgage before issuing the loan.

In the early and mid-2000s, lenders often gave out mortgages without giving a second thought as to whether borrowers could actually afford the payments. Lenders regularly skipped verifying the borrowers' incomes and, in many cases, offered low initial "teaser" interest rates that would eventually adjust and lift the monthly payments to an unaffordable level. These actions contributed to the subsequent mortgage crisis when thousands of homeowners fell behind in payments and went into foreclosure and ultimately led the country into a recession.

Congress responded by passing the Dodd-Frank Wall Street Reform and Consumer Protection Act (the Act). This law gave the Consumer Financial Protection Bureau (CFPB) the authority to both implement the new requirements of the Act, as well as adopt new rules to protect consumers in mortgage transactions. In part, the rules set out an "ability to repay" (ATR) requirement for virtually all closed-end residential mortgage loans. (A "closed-end loan" is a loan that must be repaid in full by a specified date.)

Minimum Standards for Determining Whether a Borrower Can Repay a Mortgage

The ATR rule provides eight specific factors that the lender must consider to make a reasonable, good-faith determination that the borrower has a reasonable ability to repay the loan. Those factors are:

  • the borrower's current or reasonably expected income or assets (excluding the property that secures the loan) that the borrower will rely on to repay the loan
  • the borrower's current employment status and income, which must be verified
  • the mortgage loan payment amount
  • any payments on simultaneous loans that are secured by the same property, like second mortgages
  • ongoing expenses related to the mortgage loan or the property, such as property taxes, insurance, HOA dues, and ground rent
  • other debt obligations, like alimony and child support payments
  • monthly debt-to-income ratio or residual income, and
  • the consumer's credit history, which the lender must verify. (12 C.F.R. §1026.43).

The rule doesn't restrict the lender from considering additional factors as well if it so chooses.

Exceptions to the ATR Rule

Here are some situations when the lender doesn't have to comply with the ATR rule.

Refinancing Interest-Only and Negative Amortization Loans

Under certain circumstances, the lender doesn't have to comply with the ATR rule if it is refinancing a borrower from a risky mortgage, such as an interest-only loan (when you pay only the interest without paying down the principal) or a negative amortization loan (when the loan principal increases over time, even though you're making payments) to a more stable one, such as a fixed-rate mortgage.

So, it's easier for lenders to help borrowers who have adjustable-rate, interest-only, or negative-amortization loans refinance into a standard mortgage.

Other Exceptions

While the rule applies to most mortgages, it doesn't apply to:

  • open-end credit plans, like home equity lines of credit
  • timeshare plans
  • reverse mortgages
  • temporary or bridge loans (those with terms of 12 months or less with possible renewal)
  • a construction phase of 12 months or less (with possible renewal) of a construction-to-permanent loan, and
  • consumer credit transactions secured by vacant land.

Certain creditors, such as particular nonprofit organizations, and loan programs, like state Hardest Hit Fund programs, are also exempt from the rule.

Qualified Mortgages Are Presumed to Comply with the ATR Rule

The rule presumes that a lender who makes a Qualified Mortgage (QM) has met the requirements of the ATR rule. QMs are generally loans that don't have the risky mortgage features that contributed to the mortgage crisis. For example, QMs typically cannot have:

  • an interest-only period
  • negative amortization
  • a balloon payment (a large payment at the end of the loan term) in most circumstances, or
  • a loan term longer than 30 years.

Violations of the ATR Rule

With this rule, you would think that lenders wouldn't give out loans to borrowers who can't afford them, but that might not always be the case. Fortunately, remedies are in place. If you take out a mortgage and subsequently have difficulty repaying the loan, you could potentially be able to make a claim that your lender failed to make a reasonable, good-faith determination of your ATR before giving you the loan (assuming no sudden and unexpected job or income loss happened after the loan origination and that it's a mortgage covered by the rule).

If you raise a violation of the ATR rule as a defense to a foreclosure action, the lender could be liable for certain penalties and damages, as well as attorneys' fees. (A three-year statute of limitations applies to ATR claims brought as affirmative cases, but no time limit applies on raising this as a defense to foreclosure, although the amount of recoupment or setoff is limited.)

For More Information

To learn more, go to the CFPB's website and search for "Ability to Repay and Qualified Mortgage Standards Under the Truth in Lending Act (Regulation Z)." Then follow the link.

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