If you’re current or aspiring homeowner, we have good news for you! Effective this month, new common-sense rules will help ensure that lenders treat borrowers fairly. The new rules come from the Consumer Financial Protection Bureau (CFPB), a federal agency tasked with protecting consumers.
Thanks to the financial crisis, we know all too well that the fate of our economy is deeply connected to the mortgage market. What went wrong? As Sen. Elizabeth Warren put it, “The fundamental problem was that many lenders issued mortgages without any concern about whether the borrower would be able to repay those mortgages in the long run. Now, why would they do that? They did it because they could immediately sell the mortgage to another financial institution. If the borrower couldn’t pay, that would turn out to be someone else’s problem.”
This cost American families trillions of dollars. All communities were hurt, and communities of color were hardest hit; the racial wealth gap deepened alarmingly due to foreclosures, job losses, tightened credit, and depleted retirement savings.
So keeping the mortgage market fair and safe is in everyone’s best interest.
Now that these new rules are in place, what would they mean for you if you walked into a bank today seeking a mortgage or mortgage assistance? Wonder no more! Here is a quick-and-skinny guide to your rights and protections under the new rules:
- Ability to Repay: Gone are the days of the notorious “liar loans” in which unscrupulous lenders simply made up numbers with no proof of the borrower’s income or assets. All mortgages now must demonstrate that the borrower can in fact pay the loan back. Lenders now must verify your “ability to repay,” which can happen in one of two ways:
- You can meet the standards of a Qualified Mortgage. This type of mortgage is presumed to be a safer loan because it meets certain requirements, which I’ll explain in a moment.
- Or, your borrower will have to do some homework to make a reasonable, good-faith effort to determine that you’ll be able to repay the loan.
- Information your lender will consider: No matter what kind of mortgage you have, generally, your lender will consider eight types of information:
- your current income or assets
- your current employment status
- your credit history
- the monthly payment for the mortgage
- your monthly payments on other mortgage loans you get at the same time
- your monthly payments for other mortgage-related expenses (such as property taxes),
- your other debts
- your monthly debt payments, including the mortgage, compared to your monthly income (debt-to-income ratio) or how much money you have left over each month after paying your debts.
- Qualified Mortgage: There are several elements to a Qualified Mortgage. One of the most important is that your debt-to-income ratio (including your mortgage payments) can’t be higher than 43 percent—that is, what you owe on your regular debt each month can’t be more than 43 percent of your monthly income. Qualified Mortgages also can’t have risky features like negative amortization. In negative amortization, if you make your payments as scheduled, the amount you owe goes up, not down, as you’d expect—and yes, bizarre as it seems, that really happened during the bubble. They also can’t have interest-only payments or unfair features like excessive points and fees.
- Non-Qualified Mortgage: If you don’t have a Qualified Mortgage, you can still demonstrate your ability to repay your loan. You’ll need to be prepared with reliable documents, such as a W-2 or pay stub.
- Protections against steering: Before the financial crisis, some mortgage brokers that were entrusted to find borrowers the best mortgage actually got compensated by lenders to steer borrowers into high-cost mortgages. These shady under-the-table deals are now banned.
These rules will make getting a mortgage a lot safer. And that’s only the beginning! Stay tuned for Part II, where I’ll talk about new protections that kick in once you have a mortgage.