The country's top consumer watchdog group issued new rules Thursday that aim to prevent a rerun of the high-risk junk home loans that fed the nation's disastrous housing boom and collapse.
The rules from the Consumer Financial Protection Bureau require lenders to assure borrowers can repay a home loan and restrict toxic features such as interest-only payments, even as they create some legal protections for lenders.
"This is a simple, obvious principle that needs to be cemented in the housing market," bureau head Richard Cordray said in a statement. "To put it simply: Lenders should not set up consumers to fail."
The rules take effect next January. But they are complex, and reaction was swift from all sides, with nearly everyone finding something to dislike.
Alys Cohen, a lawyer at the National Consumer Law Center, told bureau officials at a field hearing Thursday in Baltimore that the rules still give lenders too much protection and leave the market vulnerable to another financial crisis.
But Debra Still, chairman of the Mortgage Bankers Association, said she worries the regulations could lead lenders to pull back on loans that might create greater risk of litigation, harming the housing recovery.
The Financial Services Roundtable, which represents the country's largest financial institutions, said the industry may need more than a year to comply. Executives at Minneapolis-based U.S. Bancorp, a major mortgage player, said it was too early to comment on the rules' impact.
An overarching ability-to-pay rule that applies to all home loans will require lenders to evaluate a borrower's income and ability to repay a mortgage over the loan term, not a teaser period, by reviewing and verifying a borrower's financial and debt records.
Lenders must consider the borrower's monthly debt-to-income ratio, or the percentage of a borrower's monthly gross income that would go to pay debt. This should prevent loans that required little or no documentation of borrowers' incomes from rearing their heads.
The devil appears to be in what comes next.
"Qualified" mortgages cannot be interest-only loans, for instance, and cap a borrower's debt-to-income ratio at 43 percent. They also limit the points and fees that can be tacked on.
But the regulation creates two kinds of qualified mortgages. One tier includes higher-priced mortgages for riskier borrowers that carry a "rebuttal presumption." That clause keeps the door open for borrowers to seek legal remedies if they feel a lender knowingly gave them a loan when they didn't have sufficient income.
The other tier is for traditional lower-priced prime mortgages for prime borrowers that carry a "safe-harbor status" clause. That clause creates greater protections for lenders from litigation if borrowers try to challenge them. Consumers can still sue, but that basis for suing is very narrow.
Lenders can make unqualfied mortgages, but they won't get the legal protections.
"We're relieved that subprime borrowers appear to have reasonable protections," Cohen said. "And we're very concerned about the incentives to move abuses to corners of the prime market."
Prentiss Cox, a consumer law expert at the University of Minnesota law school, said he would have given the rebuttal presumption to all borrowers. But he called the new regulations a "reasonable and thoughtful effort" to resolve the conflict between two broad sets of goals.
"One can read it as compromise between the industry's desire for complete immunity and the consumer advocates' desire to allow individual consumers to raise claims based on their particular circumstances," he said.
Right now, of course, underwriting is tight and many borrowers cannot take advantage of ultra-low interest rates. Most of the exotic loans, so notorious during the crisis, are a thing of the past. Cox called the new mortgage regulation "an afterlife fight about the scope of borrowers' rights."
Cox noted that Minnesota enacted very similar ability-to-repay standards back in 2007. "We were way ahead of the pack," he said.
David Stevens, president and CEO of the Mortgage Bankers Association, said he expects most of the impact to come at the entry level and jumbo level of the market.
First-time home buyers may find it more difficult to score a loan as lenders get more cautious about their underwriting, he said, and the market for jumbo loans -- mortgages generally above $417,000 that are too big for government backing -- will likely tighten up as the pool of qualified buyers shrinks.
Guy Cecala, publisher of Inside Mortgage Finance, said he thinks the rules will limit the way banks can distinguish themselves from one another, making it more of a commodity market.
Ron Peltier, chairman and CEO of Minneapolis-based HomeServices of America Inc., agreed. The silver lining here, he said, is that there are clear guidelines for banks to play by, which could loosen some lending.
"It's finally brought some clarity to a very murky, cloudy understanding of what a qualified mortgage is going to be," he said.
Jennifer Bjorhus • 612-673-4683