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Cordray: Rule Will Restore More Certainty to a Market That was Deeply Destabilized
Jan 11 - Below is a speech given by Richard Cordray, director of the Consumer Financial Protection Bureau, at an Ability-to-Repay Rule field hearing on Jan. 10, 2013, in Baltimore.
Let me say thank you to everyone, including our elected leaders, for joining us today as we announce our Ability-to-Repay rule – a rule designed to ensure that lenders are offering mortgages that consumers can actually afford to pay back. This is a simple, obvious principle that needs to be re-established in the housing market. It is nothing more than the true essence of “responsible lending.”
The Ability-to-Repay rule gets at the heart of the lending standards used in this country to sell mortgages to consumers. It comes against the backdrop of two distinctly different mortgage markets that we have experienced over the past decade. In the run-up to the financial crisis, we had a housing market that was reckless about lending money. It was driven by assumptions about property values that turned out to be badly wrong. It had dysfunctional incentives, with lenders being able to off-load virtually any mortgage into the secondary market regardless of the quality of the underwriting. There was broad indifference to the ability of many consumers to repay loans.
As a result, we experienced the worst financial crisis since the Great Depression. The collapse of the housing market destroyed businesses and jobs across every economic sector and in communities all across the country. The American dream of homeownership was shaken to its foundations. Household wealth shrank by trillions of dollars. The stock market plummeted. People’s life savings were devastated. People lost their jobs. People lost their homes. People lost their hope and confidence in the future.
Now, in the wake of the financial crash, we have been experiencing a housing market that is tough on people in just the opposite way – credit is achingly tight. Since 2008, most mortgages are being priced on very attractive terms. But access to credit has become so highly constrained that many consumers cannot borrow to buy a house even with strong credit.
Both periods have hurt individuals and families who simply seek to fulfill the promise of the American dream of homeownership. Our goal with the Ability-to-Repay rule is to make sure that people who work hard to buy their own home can be assured of not only greater consumer protections but also reasonable access to credit so they can get a sustainable mortgage.
Let me tell you two sets of stories that reflect the problems I am talking about. Earlier this year, a California man named Henry wrote to the Consumer Bureau. His home was in the process of being foreclosed on and he was desperate. During the overheated years, a lender had sold him a mortgage for more than half a million dollars – far more than he could afford on his annual salary of less than $50,000. And despite various provisions in the original loan, he was now arriving at the point of financial ruin. Henry said that when he got the mortgage, he assumed that the lender knew what it was doing by qualifying him for such a large loan. When he wrote to us, he was worried not only about losing his home, but about losing his family’s entire future.
As we all know, Henry was not alone. People across the country were sold mortgages that were not sustainable. Some had their eyes open, seeking to ride the wave of rising housing prices. Others, like Henry, were led astray. For many borrowers, the numbers were ignored or fudged to get the loan approved. This kind of reckless lending was an endemic problem. I firmly believe that if the Ability-to-Repay rule we are announcing today had existed a decade ago, many people like Henry could have been spared the anguish of losing their homes and having their credit destroyed. The events that caused the financial crisis might well have been averted. The tragic reverberations that continue to affect so many Americans today would never have occurred.
In contrast, consider these more recent situations. Anthony from New York contacted us earlier this year to describe how after years of building a strong credit report, he now finds that even with a solid credit score and money saved for a substantial down payment, he cannot get approved for a mortgage. After all those years of carefully managing his money, he has found that the current market has become so tight that he cannot get the approval he needs. And the slowdown in the mortgage market is holding back consumers in other ways too. We heard from a couple in Michigan who have credit scores in the 800s and simply want to refinance their home, which is now worth much more than the original mortgage loan, at the current lower rates. Yet they cannot get approved because there were no comparable sales in their neighborhood over the last twelve months.
Having the important Ability-to-Repay rule in place – indeed, having all of the mortgage rules in place and on sound footing – is an essential foundation for our much-needed recovery in mortgage lending. We believe this rule does exactly what it is supposed to do: It protects consumers and helps strengthen the housing market by rooting out reckless and unsustainable lending, while enabling safer lending.
In the end, the Ability-to-Repay rule will help ensure that lenders and consumers share the same basic financial incentives – both of them win when borrowers can afford their loans. It also recognizes the importance of restoring reliability to the marketplace. When consumers sit down at the closing table, they should be able to have confidence that they are not being set up to fail. With this confidence, consumers can be more active participants in the market once again. They can choose the product they believe is best for them from among a wide variety of products, and they can decide what they are willing to pay to finance the home they seek to own.
The core of the Ability-to-Repay rule rests on two basic, common-sense precepts: Lenders have to check on the numbers and make sure that the numbers check out.
Why is this so important? Again, consider where we were just a few years ago in the mortgage market. Leading up to the crisis, many lenders sold no-doc and low-doc loans, where consumers were “qualifying” for loans that were well beyond their means. A no-doc loan is one where the borrower did not have to show any financial background and resources, such as tax forms or paychecks or bank statements – none of the critical information needed to evaluate what size mortgage he or she could reasonably afford. Some of these loans were derided as “NINJA” loans – no income, no job, no assets – yet far too many borrowers found that they had no problem getting these loans approved.
Taking the actual financial background of the consumer out of the equation was problematic. The rapid spread of introductory teaser rates made a bad situation worse. Low initial teaser rates led many consumers to believe they could afford to take out loans. But the payments proved too much for many consumers and caused a dramatic increase in mortgage delinquencies. That led inevitably to home foreclosures.
Under our new rule, lenders will have to determine a borrower’s ability to repay. They will have to evaluate the borrower’s income, assets, savings, and debts. And this determination will be based on both the principal and the interest on the mortgage over the long term – not just during an introductory period. Under our new rule, low- and no-doc loans will be effectively prohibited, and affordability will be determined based on the interest rate that would prevail in the absence of any teaser rates. In these key respects, borrowers no longer will be sold mortgages that are predestined to fail.
Now, while Congress directed the Bureau to implement the Ability-to-Repay rule, it also directed us to define a category of loans where borrowers would be the most protected. So as part of the rule, we are releasing the criteria for what are called “Qualified Mortgages.” If you are a borrower getting a Qualified Mortgage, your loan is required to meet those criteria and thus, barring some unexpected turn of events, you should be able to make your house payments.
Under our new rules, Qualified Mortgages cannot contain certain features that often have harmed consumers. They cannot have excess points and fees, which are the upfront costs that a lender imposes on the borrower at the outset of a loan. They cannot be risky loans such as negative-amortization loans, where the principal amount actually increases for some period because the borrower does not even pay the interest and the unpaid interest gets added to the amount borrowed.
And they cannot be loans that place a particularly large financial burden on the borrower. The consumer’s total monthly debts – including the mortgage payment and related housing expenses such as taxes and insurance – generally cannot add up to more than 43 percent of a consumer’s monthly gross income. No standard is perfect, but this standard draws a clear line that will provide a real measure of protection to borrowers and increased certainty to the mortgage market.
Taken together, all of the Ability-to-Repay provisions will help establish the principles of responsible lending for the mortgage market as it recovers from the financial crisis. But you cannot have responsible lending unless you have lending in the first place, and the mortgage market as it stands today has tightened so much that many consumers cannot borrow to buy a home even with a strong credit history. We can draw up the greatest consumer protections ever devised, but if consumers cannot get credit, then there is nothing to protect. Our goal here is not only to stop reckless lending, but to enable consumers to access affordable credit.
Our Ability-to-Repay rule will restore more certainty to a market that was deeply destabilized by the financial crisis. By providing common-sense discipline in the housing market, this rule creates a level of assurance for all participants that will open up more access to credit for consumers. And we are helping this process along in two ways. First, we have included provisions in the rule that temporarily broaden its coverage of Qualified Mortgages to allow a transitional period while other parts of the government, including the Congress, map a path forward toward reform of the secondary market for mortgage financing.
Second, we have addressed the legal consequences of a Qualified Mortgage by conferring the strongest legal protection on safer prime loans, while permitting borrowers to rebut the presumption of ability to repay for subprime loans. We have limited the opportunities for unnecessary litigation, however, in three ways: by drawing bright-line criteria to define a Qualified Mortgage; by specifying that sustained payment over a reasonable period is strong evidence that the borrower had the ability to repay the loan when it was made; and by specifying the circumstances under which a borrower can rebut the presumption for subprime loans.
There has been some confusion about what these legal protections actually mean. They do not afford lenders complete immunity when it comes to foreclosures. For example, if a lender does not follow the Qualified Mortgage criteria, then the lender does not enjoy the legal protection of a Qualified Mortgage. And the protections conferred on borrowers under other federal consumer financial protection laws still apply. Thus, the Ability-to-Repay rule does not take away any consumer rights; it adds to them. And for lenders who make Qualified Mortgages or determine the consumer’s ability to repay over the life of the loan, this rule will foster consumer confidence and improve conditions in the marketplace.
While working on the Ability-to-Repay rule, we came to another important recognition. Many have said, including myself, that community banks and credit unions did not cause the financial crisis. Their traditional model of relationship lending has been beneficial for many people in rural areas and small towns across this country, including the small town in Ohio where I was born and raised. They find ways to make loans that respond to personal situations and cannot be captured by any generic metrics. They depend on keeping a good reputation in the community, and they often hold those loans in their own portfolio. Accordingly, they have strong incentives to pay close attention to the borrower’s ability to repay.
So today we will also be proposing a further adjustment to the Ability-to-Repay rule to create a special category of Qualified Mortgage loans made by smaller lenders such as community banks and credit unions. This proposal also contains measures to ensure that nonprofit groups and state housing agencies that lend to low- and moderate-income families can continue to play a vital role in the housing market. These groups offer a valuable range of financing and support, from down-payment assistance to first-time homebuyer programs to construction programs that build up communities one beam at a time. We look forward to considering your feedback, which has been so helpful to us in resolving the many difficult challenges posed by the Ability-to-Repay rule.
We have adopted today’s rule after analyzing extensive comments and considerable data. We have listened to people with many different perspectives and stakes in the housing and mortgage markets. We have met with large providers, small providers, community groups, consumer organizations, and public officials from every branch and level of government. The work done by our team on this rule has been marked by their tremendous talent and dedication.
And yet their work is not done. We have a responsibility not just to write a rule, but to see that lenders put it into place effectively so that its promise for consumers becomes reality. And we also want to help lenders implement the rule smoothly and minimize unnecessary burdens. So we have hired a mortgage industry veteran to coordinate these efforts.
We also will be working closely with industry over the next year to aid and support implementation of the Ability-to-Repay rule and all of our other mortgage rules. We will publish plain-language translations of the rules in booklet and video form for lenders and other key players in the real estate market. We will field questions and offer suggestions to help lenders determine how to implement the rules. And in coordination with our fellow agencies, we will publish materials that help lenders understand supervisory expectations. As the effective date approaches, we will also give consumers information about their new rights under these rules.
On a final note, I believe it is entirely fitting that this rule, one of our most important to date, would focus on making sure that lenders pay close attention to whether borrowers are able to repay their loans. It is fitting because it brings us back to the very origins of our mission.
Five years ago, then-Professor Elizabeth Warren wrote a groundbreaking article entitled “Unsafe at Any Rate.” In it, she asked why we had made it impossible to buy a toaster with a one-in-five chance of bursting into flames and burning down your house, yet it was still possible to finance a home purchase with an exploding mortgage that has the same one-in-five chance of causing your family to be put out on the street. She advocated that financial products should be subject to regulatory oversight because “the pain imposed by a dangerous credit product is even more insidious than that inflicted by a malfunctioning kitchen appliance.”
Spurred by the tragedy of an intervening financial crisis, Congress and the President took action and her vision became the Consumer Financial Protection Bureau.
As the American mortgage market ebbs and flows, the new Consumer Bureau has been charged with the duty to protect responsible lending in the housing market for borrowers, lenders, and everyone else who is engaged in our economic life. We have been working hard, and we will continue to work hard, to do just that. Thank you.