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Mortgage Crisis Watch Business and legal issues affecting: loan repurchases | mortgage-backed securities | mortgage insurance

Dodd Frank Act: The Arrival of the ‘Ability to Repay’ Lending Restrictions

The days of exotic mortgage programs like “no doc” and balloon loans may be over.

Earlier this month, the long awaited (and by many lenders and experts, dreaded), lending restrictions codified in the Dodd Frank Act finally went into effect. The rules, promulgated by the Consumer Financial Protection Bureau (CFPB), attempt to constrain lenders’ abilities to fund loans to borrowers who lack adequate repayment capacity.

Rule Requires Lender to Determine Loan Repayment Capacity; Failure to Fulfill Requirements Has Legal Implications

During the Housing Bubble, lending only to those borrowers who could reasonably afford the properties they sought to acquire became somewhat of a novelty. The Ability to Repay Rule seeks to get back down to brass tacks in lending by requiring a mortgagee to make a “reasonable and good faith determination” of a borrower’s repayment capacity each time a loan request is made, by requiring lenders to utilize reliable third-party verification of underwriting factors such income, assets, employment, credit history, and monthly obligations. Lenders must retain documents supporting each underwriting decision for at least three years after funding the loan.

The Qualified Mortgage portion of the rules offers lenders a safe harbor by creating a presumption of compliance with the Ability to Repay Rule. A loan is classified as a Qualified Mortgage if it has a term of 30 or fewer years, involves points and fees less than or equal to 3%, and does not contain elements that could give rise to “borrower surprise” such as teaser interest rates that balloon in later years, or negative amortization where minimum payments are insufficient to keep up with the accumulating interest. Subject to a few exceptions, qualified mortgages must also typically have a debt-to-income (DTI) ratio of less than 43%.

A lender’s failure to fulfill the requirements of the Ability to Repay Rule may subject it to a number of legal consequences. First, should the lender later foreclose on the property, the borrower may be entitled to set-offs and recoupments of finance charges and fees expended in connection with the loan, plus legal fees and actual costs necessitated by the foreclosure action. Additionally, the CFPB may initiate compliance action against the lender within three years of the date of the loan origination, or “consummation” of the transaction.

Statute of Limitations Rule Reinforces Court Precedent

The fact that the three-year statute of limitations period for the CFPB to initiate an enforcement action commences at the time of funding, rather than when the CFPB discovers the defect, may help shed light on an important issue currently raging in the world of mortgage repurchase litigation. Litigants in these cases, as well as the courts, have long butted heads over whether the statute of limitations should be measured from the time of the loan sales, or the time of the discovery of the loan defects. Some argue that the appropriate period for bringing a suit for improper origination, whether in a private repurchase action or in a public CFPB compliance suit, cannot be dictated by the date of discovery of the loan defect, which we have observed typically occurs at the claimant’s convenience, often years after the fact and, when taken to its logical extreme, could turn out to be decades down the line. A recent decision out of New York has held that the time of the loan sale is the applicable date, and the newly instituted Dodd Frank provisions seem to underscore the policy behind this decision. Lenders must have some repose and cannot be expected to retain documents forever.