NEW YORK ( TheStreet) - The Consumer Finance Protection Bureau is set to unveil on Thursday
new rules for the mortgage market designed to protect borrowers from abusive lending practices that characterized the boom years. Under the new rules, banks are legally responsible for ensuring that borrowers have an "ability to repay" a mortgage. Banks that make a"qualified mortgage", as defined by the final rule, are assumed to have met the ability- to- repay criteria and will receive legal protection from lawsuits. The degree of legal protection will be greater in the case of prime loans and lower in the case of high-priced sub-prime loans. Qualified mortgages cannot have risky loan features such as interest-only payments, or negative amortization features or terms that exceed 30 years. There will also be no excessive upfront points or fees. To ensure that borrowers have an ability to repay the loan, banks will have to verify that consumers' total monthly debt does not exceed 43% of his or her pre-tax income. Loans that meet the affordability standard of Fannie Mae, Freddie Mac and the FHA also will be considered a qualified mortgage, though this standard is likely to phased out once the GSEs are out of conservatorship or at the end of seven years, whichever is earlier. The rules are to take effect in January 2014. Read more on the criteria here. "When consumers sit down at the closing table, they shouldn't be set up to fail with mortgages they can't afford," said CFPB Director Richard Cordray in a statement. "Our Ability-to-Repay rule protects borrowers from the kinds of risky lending practices that resulted in so many families losing their homes. This common-sense rule ensures responsible borrowers get responsible loans." Cordray will make a formal announcement of the rule in a hearing in Baltimore on Thursday at 11 a.m. KBW analyst Brian Gardner said in a note early Thursday that the final rule had few surprises and might not do much to shake up the mortgage market as it currently stands. "We doubt it will be a game changer for the mortgage and housing markets because many of the lending practices the QM rule will try to restrict were discontinued in 2007-2008. This will be a classic case, in our view, of the horses already being out of the barn," he wrote.
In the aftermath of the crisis, the biggest banks including Bank of America ( BAC), JPMorgan Chase ( JPM), Citigroup ( C) withdrew from sub-prime mortgage market and now more than 90% of all loans that are originated are GSE and FHA loans. Still, he expects the rule to be a modest positive for housing and mortgage originators because it provides some clarity on the future of mortgage lending. The rules are expected to pave the way for a standardized mortgage market in the future, where 30-year fixed rate mortgages will dominate, while no-doc loans and balloon loans will be a thing of the past. Banks have indicated that they will largely stick to qualified mortgages given the enhanced legal protection associated with them. The protection from unnecessary litigation should, however, incentivize banks to loosen credit that has been overly tight. "All of the Ability-to-Repay provisions will help establish the principles of responsible lending for the mortgage market as it recovers from the financial crisis," Cordray said in prepared remarks. " But you cannot have responsible lending unless you have lending in the first place, and the mortgage market as it stands today has tightened so much that many consumers cannot borrow to buy a home even with a strong credit history." " We can draw up the greatest consumer protections ever devised, but if consumers cannot get credit, then there is nothing to protect. Our goal here is not only to stop reckless lending, but to enable consumers to access affordable credit." In providing legal protection to banks, the CFPB makes a distinction between prime and sub-prime loans, offering a "safe harbor" to lenders for lower-priced loans made to borrowers who pose fewer risks. If a low-priced loan goes south, lenders will be considered to have legally satisfied the "ability-to-repay requirements". The consumer can still legally challenge the bank in court by arguing that the loan does not meet the definition of a qualified mortgage. For higher-priced loans made to borrowers with a riskier profile- sub-prime loans- lenders will have less legal protection. If the loan goes south, the consumer can rebut the presumption that the banks met the ability to repay standard. They can prove in court that the lender did not consider their living expenses after their mortgage and debts.
Higher-priced mortgage loans are generally defined as mortgages that exceed prime offer rates for comparable transactions published by the Fed by at least 1.5 percentage points. The CFPB emphasized that the rules do not prevent the borrower from challenging a lender for violating any other federal consumer protection laws. The CFPB proposes to exempt certain nonprofit creditors that work with low- and moderate-income consumers to the rule and would also make exceptions for certain homeownership stabilization programs; such as those that offer loans made in connection with the Making Home Affordable program; which help consumers avoid foreclosure. The proposed amendments would also provide Qualified Mortgage status for certain loans made and held in portfolio by small creditors, such as community banks and credit unions. -- Written by Shanthi Bharatwaj in New York.