WASHINGTON-The Consumer Financial Protection Bureau's new rules for mortgage lenders reflect a belief that an overly restrictive rule would have been more harmful to consumers than no regulations.

That is the message from Richard J. Andreano, Jr., a partner in Ballard Spahr LLP's Business and Finance Department.

Andreano said it was clear the CFPB was "trying to get it right" with the new rules, which will take effect Jan. 10, 2014, noting that mortgage industry likely will seek improvements to it. "The bureau understood if the rule was too restrictive it would hurt consumers in the long run," he added.

The section of the CFPB's mortgage rule that drew the most attention concerned the determination of a borrower's ability to repay. Again, Andreano said, the general reaction from the industry is "things could have been worse."

"Usually a new rule is more constraining, not more liberal," he pointed out. "I think the Bureau looked at issues presented by the Fed's proposed rule. There were a number of things the Bureau decided, and on other issues the Bureau expects to still make changes."

According to Andreano, the hope of consumer groups was that the term "qualified mortgage" would be defined in a broad enough manner to encompass the majority of the market. He said the "big question" was where the qualification standard would be drawn. "As it turns out, the Bureau split the baby," he said. "For loans that meet the criteria for a qualified mortgage, it is a safe harbor. The initial view out of the gate is all will be made are qualified mortgages. Whether any lender will make a loan that is not a qualified mortgage remains to be seen."

The Death Of Sub-Prime Loans?

Given the establishment of a general ability-to-repay standard, Andreano said sub-prime loans will probably become non-existent. "Jumbo loans also may become scarce," he predicted. "The Bureau did not set a higher benchmark for jumbo loans, even while acknowledging those loans often have higher rates. The Bureau decided not to adopt a higher standard for jumbo loans, and did not think that would be significant. What I am hearing from the industry is lenders do think that is significant."

If sub-prime loans and jumbo loans dry up, there might be some consumer pressure for changes, he added.

Although this is a "final" rule, Andreano said the CFPB still is considering some changes. He expects there will be a "relatively short" comment period, with the plan to finalize any revisions in the spring.

In looking at the proposal, Andreano said there are some notable carve-outs, some of which were still being amended at press time (see related story). "The Bureau realized some carve-outs were worthy of inclusion, but were too significant to include in the final rule without comment," he assessed.

One possibility is exemptions for loans made under the HAMP or HARP programs, because those were made to borrowers with difficulties.

The rule includes a "significant" proposal for smaller entities, defined as those with less than $2 billion in assets and particularly referring to small community banks and credit unions. Andreano said the CFPB noted these entities tend to make loans that they keep rather than selling to the secondary market, and they did not make the "funky" loans that led to consumers getting in trouble.

Exemption Under Construction

Because these lenders are "different," he continued, and because those types of portfolio loans are important, the CFPB is proposing an exemption that would create a separate category of qualified mortgages, only for small creditors.

"The intent is to subject these loans to underwriting and verification standards, but not the full standards that are in the rule," he explained. "Lenders would have to verify debt and income, and consider debt-to-income ratio, but if the loans are held in portfolio the exemption is seen as warranted. These lenders are doing relationship lending, making a loan to people they know that they think they can repay."

Individual credit unions will have to look at this exemption and decide if it works for them, Andreano advised. In addition to the asset size limit, to qualify for the exemption an institution could not have booked more than 500 first lien mortgages in the prior calendar year.

"The message from Dodd-Frank, which has been repeated by [CFPB Director Richard] Cordray, is 'whoever was responsible for the problem, it wasn't community banks and credit unions,'" Andreano said. "The Bureau has shown it will consider small entities differently, and recognizes one size does not fit all."

Next up for the CFPB is a mortgage servicing rule expected to be released after press time. Andreano said the CFPB probably will come out with a final rule near the proposed rule, with the big question being a small entity exemption.

Ballard Spahr LLP is a national law firm with more than 500 lawyers in 13 offices in the United States.

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