Fed Proposes Rule on Borrowers’ Ability-to-Repay

The ""Federal Reserve Board"":http://www.federalreserve.gov on Tuesday requested public comment on a proposed rule under Regulation Z that would require lenders to determine a borrower's ability to repay a mortgage before making the loan and would establish minimum mortgage underwriting standards.

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The revisions to the regulation, which implements the Truth in Lending Act (TILA), are in response to new consumer protection directives laid out by the Dodd-Frank Reform Act.

""The proposed rule"":http://www.federalreserve.gov/newsevents/press/bcreg/bcreg20110419b1.pdf would apply to all consumer mortgages, with the exceptions of home equity lines of credit, timeshare plans, reverse mortgages, and temporary loans.

As outlined by Dodd-Frank, the proposal would provide ""four options for complying"":http://www.federalreserve.gov/newsevents/press/bcreg/bcreg20110419a1.pdf with the ability-to-repay requirement.

First, a creditor can meet the general ability-to-repay standard by considering and verifying specified underwriting factors, such as the consumer's income or assets.

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Second, a creditor can make a ""qualified mortgage,"" which gives the creditor special protection from liability provided the loan does not have certain features, such as negative amortization; the fees are within specified limits; and the creditor underwrites the mortgage payment using the maximum interest rate in the first five years.

The Fed is currently soliciting comment on alternative approaches for defining a ""qualified mortgage,"" which is separate from the ""qualified residential mortgage,"" or QRM, that determines lenders' responsibility in retaining a portion of the risk on loans packaged into securities.

Third, a creditor operating predominantly in rural or underserved areas can make a balloon-payment qualified mortgage.

The Fed explained that this option is meant to preserve access to credit for consumers located in rural or underserved areas where banks originate balloon loans to hedge against interest rate risk.

Lastly, a creditor can refinance a ""non-standard mortgage"" with risky features into a more stable ""standard mortgage"" with a lower monthly payment.

This option is meant to preserve access to streamlined refinancings.

The proposal would also implement the Dodd-Frank Act's limits on prepayment penalties.

The Federal Reserve is soliciting comment on the proposed rule until July 22, 2011.

General rulemaking authority for TILA is scheduled to transfer to the Consumer Financial Protection Bureau on July 21, 2011. As a result, the Fed notes that finalization regarding the proposed rule will fall to the new Bureau.