The United States issued new rules Thursday restricting the kind of high-risk home loans that led to millions losing their homes in the housing collapse and sparked the financial crisis.
The Consumer Financial Protection Bureau (CFPB) set regulations that forbid lenders from granting mortgages to buyers who are not in the position to repay the loan, requiring strong documentation and basic income-to-loan ratios.
The rules also restrict lenders from offering inducements to borrowers to overextend themselves while protecting the lenders if the borrower defaults.
Both issues were hallmarks of the 2006 implosion of the housing market that left millions unable to pay their mortgages and sparked the near-collapse of the US financial industry, with the government forced to prop up or rescue a number of major institutions.
The economy still suffers from the property crash, with more than 10 percent of all home loans in default and foreclosure, though the market has strengthened somewhat in the past year.
“To put it simply: lenders should not set up consumers to fail,” CFPB director Richard Cordray said in a statement.
“When consumers sit down at the closing table, they shouldn’t be set up to fail with mortgages they can’t afford.”
He added: “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.”
The new rules require banks to fully document a borrower’s financial status — his or her income, debts, and other assets and obligations — to show that the borrower can pay back the loan.
“This means that lenders can no longer offer no-doc, low-doc loans, where lenders made quick sales by not requiring documentation, then offloaded these risky mortgages by selling them to investors,” the CFPB said.
In addition, the lender cannot bait borrowers with “teaser” loan rates that hide the true long-term cost of a mortgage.
The housing bubble that built up for years before the 2006 collapse was constructed in part on borrowers being offered extremely low, affordable interest rates at the beginning but which later ballooned to levels borrowers had no hope of paying.
The CFPB also established a new category of “qualified mortgages” that meet basic standards of soundness and simplicity, including a maximum debt-to-income ratio for the borrower of 43 percent.
While lenders will not be forced to issue such loans, the aim was to set a standard that would be required by financial investors in mortgages and mortgage securities — particularly the powerful state-controlled Fannie Mae and Freddie Mac, which dominate the mortgage securitization industry.
Banks that adhere to the qualified mortgage standard will have greater protection from lawsuits.
The rules begin to take effect in January 2014, with the borrower debt ratio rule phased in over several years to avoid much negative impact on the still-weak housing market.
Banks expressed worry that the new rules would restrict their lending business.
“While the rule codifies many conservative lending standards currently in place, it is complex and technical, presenting an additional regulatory burden,’ said Frank Keating, president of the American Bankers Association.
“There is a very real impact to these rules, and they will transform our lending practices and could restrict access to credit.”
The consumer-focused Center for Responsible Lending called the new rules a “balanced, reasonable approach.”
“The standard CFPB establishes for a safe, well-underwritten mortgage is appropriately broad enough to include the vast majority of creditworthy home owners, and it is clear enough for lenders and borrowers alike to understand.”