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 years that led up to the mortgage crisis, lenders often made loans without any consideration as to whether or not the borrower could actually repay the loan. As a result, homeowners frequently fell behind in payments and went into foreclosure.

In response, the Consumer Financial Protection Bureau (CFPB) issued a rule that went into effect on January 10, 2014, which requires lenders to review a borrower's financial information and make sure that he or she can afford to repay the loan before providing the loan. Read on to learn more about the CFPB "ability to pay" rule and how it is designed to protect you.

Why the Need for the Rule?

In the early and mid-2000s, lenders often gave out mortgages without giving a second thought as to whether the borrower could actually afford it. Lenders regularly skipped verifying the borrower's income and, in many cases, offered low initial "teaser" interest rates that would eventually adjust and lift the monthly payments to an unaffordable level. This contributed to the mortgage crisis and led the country into recession.

The Dodd-Frank Act Imposes the "Ability to Repay" Rule

In response to the crisis, Congress passed the Dodd-Frank Wall Street Reform and Consumer Protection Act, which gave the 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 the 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 (for example, 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 (such as alimony and child support payments)
  • monthly debt-to-income ratio or residual income, and
  • the consumer's credit history (which the lender must verify).

The rule does not restrict the lender from considering additional factors as well, if it so chooses.

Exceptions to the ATR Rule

There are some circumstances when the lender does not have to comply with the ATR rule.

Refinancing Interest-Only and Negative Amortization Loans

Under certain circumstances, the lender does not 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 are making payments) to a more stable one, such as a fixed-rate mortgage. This makes it 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 does not 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 do not 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 cannot afford them, but that might not always be the case. But there are remedies.

After this rule goes into effect, 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 there was no sudden and unexpected job or income loss after the loan origination and that it is a mortgage covered by the rule).

If you raise this issue as a defense to a foreclosure action, the lender could be liable for, among other things, up to three years of finance charges and fees, as well as attorney's fees. (There is a three-year statute of limitations on ATR claims brought as affirmative cases, but there is no time limit on raising this as a defense to foreclosure, although the amount of recoupment or setoff is limited to no more than three years of charges and fees.)

Legal Protections for Lenders Who Make QMs

If your mortgage is a QM, the lender may be entitled to certain legal protections regarding an ATR claim.

Loans that are not higher-priced. If the QM is not a higher-priced mortgage loan (higher-priced mortgage loans are loans with higher than average interest rates), the lender is considered in compliance with the ATR rule if the loan meets the definition of a QM.

Higher-priced mortgage loans. For QMs that are higher-priced mortgage loans, lenders get a rebuttable presumption that they have complied with the ATR rule. This means it is presumed that the lender is in compliance with the rule, but you challenge that presumption by showing that you did not have sufficient income to make the mortgage payments.

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)."

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