Default Index Shows Ability-to-Repay Rules Working for Mortgage Lenders

Written By: Joel Palmer, Op-Ed Writer

For all the criticism it has received from the financial sector and from many in Congress and the White House, the Consumer Financial Protection Bureau can claim that at least one of its initiatives has helped both consumers and mortgage lenders — at least according to one industry measure.

First American Financial Corporation, which provides title insurance, settlement services and risk solutions for real estate transactions, regularly estimates the frequency of mortgage loan defects, fraud and misrepresentation through its Loan Application Defect Index. The Defect Index reflects estimated mortgage loan defect rates over time by geography and loan type. 

According to First American Chief Economist Mark Fleming, the decline in mortgage defects began almost immediately after the CFPB’s “ability-to-repay” rules took effect in January 2014.
The latest index is down 19.6 percent from its peak in October 2013, three months before the rule went into effect.

The ability-to-repay rule requires most mortgage lenders to make a reasonable and good faith determination that borrowers can pay back the loan. 

While this seems an obvious step for mortgage processors and underwriters to take, it wasn’t always happening prior to the 2008 financial crisis. As CFPB noted in making the ability-to-repay rule, “some lenders made mortgage loans that consumers could not pay back,” and that “these lenders expected to make money by relying on rising housing prices or by off-loading the mortgage into the secondary market.”

Under the rule, “lenders must generally find out, consider, and document a borrower’s income, assets, employment, credit history and monthly expenses.”The rule prohibits lenders from using introductory or “teaser” rates to determine a borrower’s ability repay a loan. If a mortgage has a low interest rate that goes up in later years, the lender has to make a reasonable effort to figure out if the borrower can pay the higher interest rate too.

First American pointed out that income-specific defect and fraud risk is 70 percent low its peak prior to the issuing of the ability-to-repay rule.

“The rules have reduced the incentive to fraudulently misrepresent one’s income, a benefit to lenders,” said Fleming. “The ability-to-repay standards are essentially the mortgage fraud risk prevention equivalent of using a steering wheel lock to dissuade potential car thieves.”

“Additionally, in order to make the good faith determination, the mortgage industry enhanced the manufacturing and underwriting practices specific to the assessment of a consumer’s income and ability to repay their mortgage,” Fleming added. “This has helped to reduce income-related loan application defects.”

Sometime by January 2019, CFPB will issue a report assessing the rule’s effectiveness. Dodd-Frank requires the bureau to review rules within five years of taking effect. CFPB solicited public comments on the rule last year.

Something that may be interesting to assess is the relationship between loan defects and the availability of housing credit. 

In April, the Urban Institute released its Housing Credit Availability Index for the fourth quarter of 2017. The index measures the percentage of home purchase loans that are likely to default, which provides an indication of mortgage loan accessibility; the lower the index, the tighter the lending standards and the more difficult it is to obtain financing. 

The latest index is at its highest level since 2013. Furthermore, mortgage credit availability in the GSE channel—Fannie Mae and Freddie Mac—has been at the highest level since its low in 2011.

It may be coincidence, but the increasing availability of housing credit has coincided with an increase in defects. On a year-over-year basis, the overall Defect Index is up 1.2 percent, while the index for purchase mortgages is up 2.2 percent since April 2017.

About the Author

As an NAMP® Opinion Editorial Contributor, Joel Palmer is a freelance writer who spent 10 years as a business and financial reporter and another 10 years in marketing for the insurance and financial services industries. He regularly writes about the mortgage industry, as well as residential and commercial real estate, investments, and retirement income planning. He has also ghostwritten books on starting a business, marketing, and retirement income planning.

Opinion-Editorial (Op-Ed) Disclaimer For NAMP® Library Articles: The views and opinions expressed in the NAMP® Library articles are those of the authors and do not necessarily reflect any official NAMP® policy or position. Examples of analysis performed within this article are only examples. They should not be utilized in real-world application as they are based only on very limited and dated open source information. Assumptions made within the analysis are not reflective of the position of NAMP®. Nothing contained in this article should be considered legal advice.