Alamy The worst financial crisis in generations resulted from a relatively simple problem: Millions of homeowners overextended themselves by borrowing more than they could afford, with the aid and encouragement of the banks. That helped artificially inflate home prices, and eventually led to a price collapse and a wave of mortgage defaults that brought the banking system to the brink of collapse.
Five years after the U.S. economy hit bottom, the Consumer Financial Protection Bureau is working to prevent a repeat of the mortgage meltdown, and its new rules, which took effect this month, represent the CFPB’s attempt to protect home buyers from some of the banking behaviors that planted the seeds the housing crisis.
Mortgages Minus Gimmicks and Surprises
The main purpose behind the new CFPB mortgage rules is to make sure that home loans are safer and involve fewer unexpected surprises.
During the housing boom, many borrowers were able to obtain loans only because of gimmicks like low initial rates that automatically rose after an introductory period. Those adjustable rate loans made the early monthly payments affordable, but when their interest rates reset higher, the resulting jump in borrowers’ mortgage payments suddenly put their budgets on tilt. That’s when many people began defaulting, setting off the avalanche that led to a collapse in home prices.
In order to encourage lending institutions to make better loans, the CFPB has introduced the concept of a “qualified mortgage.” These mortgages automatically pass the CFPB test that a lender must assess whether a borrower will be able to repay the loan — not just in the short run, but throughout the term of the mortgage.
To get a qualified mortgage, you have to have total monthly debt-to-income ratio of no more than 43 percent. That means that when you add up mortgage payments and other debt repayment like credit cards or car loans, the total has to be less than $43 for every $100 in income you earn on a monthly basis.
In addition, qualified mortgages can’t have any of the terms that got so many homeowners into trouble during the mid-2000s. Negative amortization loans, where monthly payments are so small that the loan balance actually goes up over time rather than down, aren’t permitted. Nor are interest-only mortgages. This will, for the most part, compel lenders to use traditional mortgages that automatically build up homeowner equity over the term of the loan.
Protection From High Fees, Conflicts of Interest, and Aggressive Servicing Practices
Most importantly for borrowers, qualified mortgages have limits on some of the costs involved in getting a mortgage. Between “points” and other fees that lenders often charge, the maximum amount can’t exceed 3 percent of the size of the loan.
Another key aspect of the mortgage rules addresses the way that mortgage brokers get compensated. In particular, if you pay someone directly to get a mortgage loan, that person usually can’t also get paid a commission by somebody else. That eliminates any temptation a broker might have to offer you a high-commission product that will get you into financial trouble.
Borrowers also get protection under the new rules from the companies that service their loans. You have to receive a clear monthly statement that shows how your payments were credited, and if you have an adjustable-rate mortgage, your statement has to tell you in advance when your rate is going to change.
If you fall behind on your mortgage, the new rules also give you more leverage. Servicers generally have to wait four months before starting a foreclosure proceeding, in order to give you time to request a loan modification. Once you apply for a loan modification or other help, the servicer can’t simultaneously move forward with a foreclosure proceeding, and you have the right to assistance from the mortgage servicer to help you with your options.
The CFPB’s new rules won’t entirely eliminate situations in which homeowners overextend themselves and get into trouble on their mortgage loans. And they don’t make it against the law for lenders to make non-qualified loans, though they do make it harder. Still, by making the process easier to understand and safer upfront, the rules should help many borrowers avoid completely unnecessary risks of the type that caused so many people to lose their homes during the mortgage crisis.
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