A sweeping financial measure enacted last year bars lenders from approving a mortgage without verifying that the borrower has a reasonable ability to repay it.
Lenders that violate that rule leave themselves vulnerable to lawsuits and enforcement actions. Struggling homeowners could even use violations of this rule to fight foreclosure.
But lawmakers left it up to regulators to decide how this measure should be applied in the real world — and under which conditions lenders would be free from liability.
On Tuesday, the Federal Reserve unveiled a proposal that offers two options under which lenders would be protected from court challenges. The agency will now solicit public comments on which plan would work best.
“This is really the guts of the financial reform bill,” said Michael Calhoun, president of the Center for Responsible Lending. “It’s about how do you make sure there are sustainable mortgages. As we found out, that’s not only important for home buyers and homeowners, it’s equally important for the whole economy.”
The measure enacted last year requires lenders to verify a borrower’s income, assets and other factors before making a loan — a once common practice that fell by the wayside during the housing boom and ultimately led to the nation’s financial crisis.
But lenders said that many of the factors they must verify are “squishy,” as one industry expert put it. For instance, self-employed workers who earned a steady income for years may suddenly suffer a huge loss in pay for reasons beyond their control. The industry said it should not be on the hook under all circumstances.
The Fed provided two options under which lenders can be exempt from liability. The first option protects loans that don’t have the risky features often associated with high rates of default. Those features include mortgage terms that exceed 30 years or fees that exceed 3 percent of the loan amount.
Under the second option, lenders would have to meet more standards than they would under option one and would not be totally exempt from legal challenges.
Many within the industry said the legal protections offered under option one would work best for consumers as well as lenders. Without such protections, consumers will end up paying more for the mortgages they want, they said.
“The industry’s natural reaction will be to act defensively” if lenders are vulnerable to court challenges, said Glen Corso, managing director of the Community Mortgage Banking Project, a public policy group that represents independent mortgage bankers. “It will mean less business for lenders and less credit availability and higher costs for borrowers. None of this is good for the housing market.”
The industry has long argued that market pressures have eliminated some of the loose lending practices targeted by the legislation. But lawmakers said they wanted to codify the rule so the standards are not tinkered with in the future.
The Fed will accept public comment on its rule until July 22. The Consumer Financial Protection Bureau, which will open its doors in July, will take over and finalize the proposal.