In January, the Consumer Financial Protection Bureau (CFPB) issued its Final Rule regarding lender verification of the borrower’s ability to repay (ATR) when granting mortgage financing. This means that after January 10, 2014, lenders will be required to document that borrowers can repay their mortgages.
Does this mean stated income mortgages will be illegal? Only if you call them “stated income mortgages.”
Here’s the CFPB’s take, in its own words:
It will no longer be possible to originate loans based on stated income. You must now verify the consumer’s income or assets and employment relied on in order to comply with the ATR rule.
So, how is a stated income loan legal?
Here’s the rest of that paragraph from the CFPB:
The ATR rule does not ban any particular loan features or transaction types, but a particular loan to a particular consumer is not permissible if the creditor does not make a reasonable, good-faith determination that the consumer has the ability to repay. Thus, the rule helps ensure underwriting practices are reasonable.
Responsibly underwritten stated income loans have “reasonable” underwriting standards
Stated income loans went into widespread use in the early 1990s and were actually considered quite safe. Typical requirements were 25-to-30 percent down, excellent credit, a business license, and verified non-business liquid assets totaling 6 to 12 months of the income stated. So if you were going to claim that you earned $10,000 a month, you’d have to document $60,000 to $120,000 in the bank to get approved. Other stated income or “lite doc” loans allowed the use of bank statements to prove income — if there is $10,000 a month getting deposited into your bank every month, then your income is probably about $10,000 a month.
Classic stated income loans always included some “backdoor” way of figuring out the applicant’s income — they just didn’t use FHA or Fannie Mae underwriting rules, but the rules they used worked very well.
Things got shaky when lenders began peeling off the safety nets until they were making 100 percent stated income loans to people with no verified assets — and who had awful credit to boot. Why is anyone surprised that this backfired?
Government rules have plenty of loopholes
The CFPB doesn’t require lenders to use Fannie Mae or FHA guidelines to document ability to repay. It says:
In addition to a W-2 or payroll statement, you may verify income using tax returns, bank statements, receipts from check-cashing or funds-transfer services, benefits program documentation, or records from an employer.
And guess what? You don’t have to verify all income, just what’s needed to repay the loan.
If a consumer has more income than, in your reasonable and good-faith judgment, is needed to repay the loan, you do not have
to verify the extra income. For example, if a consumer has both a full-time and a part-time job and you reasonably determine
that income from the full-time job is enough for the consumer to be able to repay the loan, you do not have to verify income
from the part-time job.
The lender doesn’t have to apply a debt-to-income ratio, either. This used to be called a “no ratio” loan.
The general ATR standard requires creditors to consider DTI or residual income, but does not contain specific DTI or residual income thresholds.
Finally, the STR standard allows lenders to consider the applicant’s assets when determining the ability to repay. Sound familiar?
Doubtless, when implementing the new standards, lenders will be all over the place in their interpretations, and the majority will go with a conservative plan until they see how things shake out. But rest assured, some lenders will push the envelope. And some version of stated income lending will makes its way into widespread use eventually.