The ability to repay a loan is an integral factor in the lending process. It’s up to the borrower to ensure they can fulfill their loan obligations, while it also falls under CFPB’s Ability-to-Repay Rule passed in 2014 under Dodd-Frank Wall Street Reform and Consumer Protection Act. In this article, we’ll take a closer look at this regulation, its exemptions, the Ability to Repay Checklist, its impacts on consumers, and more.
What is the Ability-to-Repay Rule?
The Ability to Repay Rule is a regulation that requires mortgage lenders to assess and verify a borrower’s capacity for repayment before approving them for a loan. This rule applies to most types of mortgage loans, including those for refinancing or purchasing a home. This regulation was put in place in an effort to prevent irresponsible lending practices that caused the 2008 financial crisis.
The Ability to Repay Rule, commonly referred to as Regulation Z in the Truth in Lending Act (TILA), sets out the criteria lenders must take into account when assessing a borrower’s capacity for repaying a loan. It applies across all lenders offering mortgage loans – banks, credit unions, and mortgage brokers included – regardless of size or scope.
What Does the Ability-to-Repay Rule Require?
The Ability to Repay Rule requires mortgage lenders to consider several factors when assessing a borrower’s capacity for repayment of a mortgage loan. These include income, assets, and debt obligations of the borrower as well as employment status and credit history.
To comply with the Ability to Repay Rule, lenders must follow a series of guidelines. These include verifying a borrower’s income and employment status as well as their credit history. Lenders also take into account the borrower’s debt-to-income ratio — that is, how much debt they owe compared to their income –and loan payment terms like interest rate and schedule.
Exemptions to the Ability-to-Repay Rule
The Ability to Repay Rule offers several exceptions that lenders can utilize to circumvent its requirements. These include loans made by small creditors, loans for certain types of manufactured homes, and loans through certain government programs.
Small creditors refer to those that make fewer than 500 mortgage loans annually and possess assets of less than $2 billion. They are exempt from certain requirements under the Ability-to-Repay Rule, such as verifying a borrower’s income and employment status.
Loans for certain manufactured homes are exempt from the Ability to Repay Rule. These homes must be classified as personal property rather than real estate. Furthermore, loans made through government programs like Rural Housing Service or Veterans Administration are exempt from this rule.f
Ability to Repay Rule Statistics
In January 2014, the Ability to Repay Rule was implemented as part of the Dodd-Frank Wall Street Reform and Consumer Protection Act.
Mortgage lenders must verify a borrower’s ability to repay a loan before they approve it.
The Ability-to-Repay Rule applies to most closed-end residential mortgage loans, such as those for purchasing homes, refinancing existing debt, and taking out home equity loans.
To comply with the Ability-to-Repay Rule, mortgage lenders must complete both the Ability-to-Repay Checklist and Ability-to-Repay Qualified Mortgage Rule. The latter lays out specific guidelines for loans to be classified as “qualified mortgages,” making them safer for borrowers.
To qualify for a mortgage loan, borrowers must meet certain criteria such as having a debt-to-income ratio of 43% or lower.
According to a report released by the Consumer Financial Protection Bureau (CFPB), more mortgages now meet eligibility criteria due to changes made under the Ability-to-Repay Rule.
Another study revealed that lenders are now turning towards less risky loan features like interest-only or negative amortization loans since the rule was implemented.
The Ability-to-Repay Rule has been instrumental in avoiding some of the risky lending practices that contributed to the 2008 financial crisis.