To head off another financial crisis, the government's consumer watchdog, the Consumer Financial Protection Bureau, recently announced a new rule to ensure that prospective buyers are actually able to repay their mortgage.
The Ability to Repay rule, which officially takes effect in January 2014 but will be put into place by most lenders sometime this year, protects consumers from risky practices such as "no doc" and "interest only" features that contributed to so many people losing their home in recent years.
"When consumers sit down at the closing table, they shouldn't be set up to fail with mortgages they can't afford," CFPB Director Richard Cordray said.
The new rule, spurred by 2010's Dodd-Frank financial-reform law, requires that borrowers' financial information — employment status, income, assets and debt – be supplied and verified by lenders, thereby eliminating no- or low-doc loans. That information, including debt-to-income ratio, must be used to prove that the borrower has the ability to pay back a loan.
Generally, the bureau says these mortgage rules will allow people with a debt-to-income ratio of less than or equal to 43% to get a loan.
Moreover, the rule says that banks can't use teaser rates to mask the true cost of a mortgage. Lenders must evaluate the consumer's ability to repay the principal and interest over the long term, not just for the introductory rate.
Lenders complying with the requirements of the rule (PDF) will issue a "qualified mortgage," which also ensures that the loan has no excessive points or fees, or toxic loan features, such as terms of more than 30 years, interest-only or balloon payments, or negative amortization payments where the principal amount increases.
- On our blog, 'Listed': New federal rule: Make sure borrower can pay loan