U.S. banks and housing groups are bracing for paperwork headaches and delays as major post-crisis mortgage reforms take effect later this week, but experts say prior warnings of a blow to the housing recovery will not be proven right. On Friday, lenders must be prepared to verify that borrowers can repay their home loans, under rules written by the Consumer Financial Protection Bureau and required by the 2010 Dodd-Frank Wall Street oversight law.
Banks will have to consider a list of factors that show the consumer's financial health, including income, existing debt obligations and credit history. The reform seeks to prevent a repeat of the 2007-2009 financial crisis, when millions of people's homes went into foreclosure, in many cases because the borrowers received loans they could not afford.
When it was first introduced, the change spooked both banks and housing advocates, who said a strict interpretation would force lenders to extend loans only to borrowers with spotless credit, potentially derailing the fragile housing recovery. Along the way regulators softened the rule, easing those fears. Still, banks have scrambled over the last year to update technology, write new lending procedures and train employees to comply with the requirements. Experts warn consumers could see some disruptions over the next few weeks, including longer mortgage application processing times and paperwork problems.
"We do think there could be some short-term wrinkles in the January-February time frame as the cut-over occurs and lenders have to port over to new systems," said Stan Humphries, chief economist at Zillow, an online real estate database. But he said the rules would not have much impact on the larger housing market because regulators broadened a carve-out for the most basic loans, called "qualified" mortgages or QMs.
The ability-to-repay rule had been the most feared of a series of changes looming for mortgage lenders because if borrowers' homes are foreclosed upon, they could claim their banks should have known they could not afford the loans. Dodd-Frank provides some protection from these lawsuits for lenders who issue qualified loans, which can have no risky loan features, and any associated fees must add up to less than 3 percent of the total loan amount.
In the final version, the consumer bureau said that for the first few years, any loans that are eligible for purchase by Fannie Mae and Freddie Mac count as qualified. That means most of the loans made today would get extra legal protection.
"For the foreseeable future, the vast majority, or roughly 95 percent, of the market will be covered by this QM definition, which is where the market is today," said Peter Carroll, the CFPB's assistant director for mortgage markets, in an interview. "We do believe that the market will figure out how to make good, responsible non-QM loans, and they'll make them."
Wells Fargo and some other lenders have already said they will issue non-qualified mortgages to high-wealth clients, though that market is expected to be small.
Banks Less Optimistic: The ability-to-repay rule is just one piece of a set of sweeping mortgage reforms still to come. Tough new requirements are also set to kick in for mortgage servicers. These firms normally collect payments and communicate with homeowners, but made numerous mistakes after the crisis that led many borrowers to lose their houses.
Regulators also are revamping disclosures banks must issue when making loans, and the U.S. Congress is debating ways to overhaul Fannie Mae and Freddie Mac, though that could take years. Bank lobbyists are more pessimistic than other housing experts and warn that some lenders will be overly cautious while they are getting comfortable with new requirements.
Many small banks rely on outside vendors to build the technology used to generate loan terms for borrowers. Some vendors made changes as late as December, which could keep some banks from training staff by Friday, said Robert Davis of the American Bankers Association, a trade group.
"Until the vendors have finished tinkering with the systems to get them right, and until bankers are more confident in the robustness of systems and the training of their staffs to use the systems, we believe there's going to be ... a pullback," Davis said.
Some in the mortgage industry still say it could be harder for low-income borrowers to take out a loan because lenders will feel they have less flexibility. But because loan applications take a while to close, it will take a few months to generate data on the rule's impact on the market. U.S. officials hope to track changes at a group of lenders that would indicate industry trends, the CFPB's Carroll said.
Some financial institutions say while it has been tough, they are prepared. Scott Toler, chief executive of the Credit Union Mortgage Association in Fairfax, Virginia, said on Tuesday his group made some of its final compliance upgrades this week. He said his company, which provides mortgage services to more than 70 credit unions, modified loan underwriting procedures, retrained employees and upgraded technology systems.
"It's been a lot of work, but we'll be ready," Toler said. "It's been like drinking from a fire hose to stay ahead of the new and constantly changing regulations."