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.)
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 rule doesn't restrict the lender from considering additional factors as well if it so chooses.
Here are some situations when the lender doesn't have to comply with the ATR rule.
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.
While the rule applies to most mortgages, it doesn't apply to:
Certain creditors, such as particular nonprofit organizations, and loan programs, like state Hardest Hit Fund programs, are also exempt from the 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:
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.)
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.