CFPB Targets Mortgage Patch That Enables Riskier Borrowing, Predatory Lending

Inside Subprime: August 29, 2019

By Jessica Easto

The Consumer Financial Protection Bureau (CFPB) has taken preliminary steps to close a loophole in mortgage regulation that allows banks to approve “deeply indebted borrowers” for home loans that they might not otherwise qualify for.

The provision was created after the financial crisis and allowed borrowers with debt-to-income ratios of higher than 43 percent to qualify for loans. A debt-to-income ratio compares how much money you owe each month to how much money you earn each month. The higher the percentage, the more debt you carry, which makes you “risky” in the eyes of lenders. According to the CFPB, studies have shown that home loan borrowers with debt-to-income ratios higher than 43 percent have a more difficult time making payments, so it has become a standard measure of risk for mortgage lenders.

Last year, the provision made the government responsible for an additional $260 billion in mortgages. Although the provision was intended to be temporary (it expires in 2021), the CFPB appears to be revamping the rule early to replace it with something that is tougher and that reduces the government’s role in the housing market. Mortgage and real estate industry groups, which favor looser regulation, are expected to push back on the proposed changes.

In order for the government to take a step back from the housing-finance system, banks Fannie May and Freddie Mac would need to become privately owned once again. It’s been a decade since the government took control of the financial institutions after they went belly up during the financial crisis. The government is expected to release more plans on this front soon, which will outline a path toward Fannie and Freddie guaranteeing about half of the mortgage market.

But if the debt-to-income provision is changed, it will restrict the types of loans Fannie and Freddie can buy, which will make it harder for high-debt borrowers to find mortgage lenders. According to reports, the loophole provision made about 3.3 million mortgages between 2014 and 2018 possible. Those opposed to closing the loophole argue that many Americans will be left without access to credit and that there isn’t solid proof in practice that those with ratios higher than 43 percent are less likely to make their payments.

The CFPB could decide to increase the acceptable debt-to-income ratio, which would expand that types of mortgages that Fannie and Freddy could buy. The CFPB has not yet announced what it plans to do.

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