What Is the Ability to Repay?

The ability to repay refers to an individual’s financial capacity to make good on a debt. In particular, the phrase “ability to repay” was used in the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act. It describes the requirement that mortgage originators substantiate that potential borrowers can afford the mortgage. This provision of Dodd-Frank is often called the ability-to-repay rule, and “ability to repay” is sometimes abbreviated as ATR.

Under Dodd-Frank, the Consumer Financial Protection Bureau (CFPB) has jurisdiction to create new rules and regulations for the mortgage industry. According to these rules, the loan originators must look at a borrower’s total current income and existing debt. They need to ensure that the existing debt, potential mortgage debt, and related expenses don't exceed a stated percentage of the borrower’s income.

History of the Ability-to-Repay Rule

The ability-to-repay rule was included as a response to the 澳洲幸运5官方开奖结果体彩网:mortgage crisis in 2008. Before then, lenders could provide mortgages to homebuyers whose incomes did not demonstrate the ability to pay the monthly mortgage payments. That led to the housing bubble of the 2000s and the mortgage crisis. In the end, a large number of homes faced 澳洲幸运5官方开奖结果体彩网:foreclosure at the same time. Under the new mortgage regulations stipulated by the 澳洲幸运5官方开奖结果体彩网:Consumer Financ🌱🐷ial Protection Bureau (CFPB), individuals who are not held to the ability-to-repay standard during the origination process may have a defense against foreclosure.

The ability-to-pay rule is a cornerstone of financial stability, according to a paper in The Georgetown Law Journal. Without it, 澳洲幸运5官方开奖结果体彩网:loan-to-value (LTV) limits aren't enough to curb property bubbles. Although LTV limits are important to constraining risk, the denominator—the value—will become artificially elevated during a bubble and will only fall after the bust is underway, shrouding the elevated default risk at origination and giving false confidence that mortgage risk is contained. The paper said the mortgage crisis demonstrated that the inability to repay exacerbates default risk, along with the resulting further depression in housing prices.

Requirements of Ability to Repay

The CFPB specifies eight factors that determine whether a boꦅrrower demonstrates the ability to repay. Based on these standards, the lender makes a reasonable and good-faith decision about the borrower’s ability to repay the loan.

The factors determining the borrower's ability to repay include the borrower’s current income and assets. They may also include reasonably expected income. The borrower must also provide verification of this income and their employment status.

Besides income, mortgage lenders must consider a borrower’s current liabilities. That includes any outstanding debts they are still paying, as well as child support and other monthly payments. A lender will also check a borrower’s 澳洲幸运5官方开奖结果体彩网:credit history.

Previously, lenders were asked to consider a borrower's 澳洲幸运5官方开奖结果体彩网:debt-to-income (DTI) ratio to make a final determination. But in December 2020, the DTI requirements of the ability-to-repay rule were eliminated and replaced with a price-based approach, with the CFPB noting that a loan’s price is a strong indicator of a consumer’s ability to repay.

The move to eliminate DTI requirements came partly from industry criticism of an existing exemption from DTI rules for loans backed by 澳洲幸运5官方开奖结果体彩网:Fannie Mae and 澳洲幸运5官方开奖结果体彩网:Freddie Mac.

Exceptions to the Ability-to-Repay Rule

Several types of mortgages are exempt from the ability-to-repay rule. Some of these loans include timeshare plans, home equity lines of credit (HELOC), 澳洲幸运5官方开奖结果体彩网:bridge loans, a construction phase of less than a year, and 澳洲幸运5官方开奖结果体彩网:reverse mortgages.

Loans backed by 澳洲幸运5官方开奖结果体彩网:government-sponsored enꦓt🔯erprises (GSEs), such as Fannie Mae and Freddie Mac, are exempt from DTI requirements. This exemption is called the GSE patch or 澳洲幸运5官方开奖结果体彩网:qualified mortgage (QM) patch. According to the 澳洲🌞幸运5官方开奖结果体彩网:Independent൲ Community Bankers of America (ICBA), the patch applied to 25% or more of GSE loans as of early 2020. Although the patch was set to expire on July 1, 2021, the CFPB extended the date to October 2022 because of the pandemic. Since the patch expired, the new rules regarding the ability to pay replaced the existing patch.

The Bottom Line

Some of the worst outcomes of the 2008 Great Recession stemmed from loose lending habits that weakened the housing market. In the years that followed, legislation was passed to strengthen lending rules and protect borrowers from taking on more debt than they could feasibly pay back. The Ability to Repay ensures that lenders don't qualify people who cannot repay their loans.