CFPB Rules Close Door on 'Teaser' Rates

NEW YORK (TheStreet) -- No more ticking time bombs.

That's the essence of mortgage regulations issued Thursday by the Consumer Financial Protection Bureau, the watchdog agency set up during the financial crisis. The rules are aimed at loans and practices likely to get borrowers into trouble, such as those on which loan balances can grow larger over the years, or those granted to people with too little income.

"Unaffordable loans helped cause the worst financial crisis since the Great Depression," CFPB Director Richard Cordray said in announcing the rules. "People across the country were sold unsustainable mortgages. Some may have entered with their eyes open, seeking to ride the wave of rising housing prices, but many were led astray. For many borrowers, it appears that lenders ignored the numbers to get the loan approved. This kind of reckless lending was an endemic problem."

In one sense, the long-awaited rules could be seen as a case of closing the barn door after the horse has left, as the goal is to prohibit or discourage the types of mortgages that helped bring on the financial crisis. Lenders have already become more conservative, and the toxic types of loans issued in the mid-2000s are now non-existent or nearly impossible to find.

So why bother writing new rules? Mainly because history shows the financial industry has a short memory. Often, the executives who presided in the lead-up to one crisis are gone during the approach of the next. As financial bubbles build, firms have an incentive to grab all the business they can, even if it means risking their long-term health. And executives who preside over disasters often end up rich even if they lose their jobs.

Also, risky types of mortgages are not as risky in a normal housing market because as home prices rise it is fairly easy for borrowers who run into trouble to sell and use the proceeds to pay off their loans. The recent crisis was unusually bad because falling home prices eliminated this safety valve, with many homeowners owing more than their homes are worth.

The new rules will discourage lenders from offering loans with deceptive "teaser" rates -- very low initial interest rates that are followed by higher ones that cause monthly payments to jump. Lenders would still be permitted to issue some types of risky loans, but would not enjoy the protection from lawsuits provided for safer loans. Other rules are designed to curtail the charging of excessive upfront fees. The rules distinguish between "qualified" loans sheltered from litigation because they are considered relatively safe and "unqualified" ones that would not enjoy that protection.

The safe harbor provided to qualified loans is meant to encourage more lending. That could help the housing market recover from its long slump. The new rules are designed to ensure that loans be issued only to people who have a strong likelihood of being able to make payments.

The new rule essentially outlaws the "liar loans" that contributed to the crisis. In those, lenders required no proof that borrowers had the assets and income required to pay back the loan, in effect inviting applicants to lie about their financial resources. Not only will lenders now have to verify applicants' finances, they will have to make sure applicants will have the wherewithal to make any larger payments that may result from future rate adjustments, as is common with adjustable-rate mortgages.