If The American Dream is home ownership then The American Nightmare is digging out from the mortgage.  Fortunately Uncle Sam saves the day once again in his never-ending quest to save us from ourselves.

Last week The Consumer Financial Protection Bureau as mandated under the 2010 Dodd-Frank financial reform bill released its first major rule to shape the future of mortgages.  The politically charged measures are generally less stringent than consumer groups wanted and less onerous than lenders feared.

The new rule has two parts:

Part #1 applies to all mortgages and has been relatively free from controversy.  It requires lenders to evaluate whether a borrower will be able to repay a loan based upon income, assets, credit history, debt obligations and employment status.  Lenders must verify and document this information which will do away with so-called “no doc” loans.  It’s interesting to note the new rule tells lenders what to look at but not how to evaluate the information.

Part #2 creates a new category addressing product and underwriting standards.  On the product side so called “qualified mortgages” may not use features that caused (in a real or perceived sense) the recent housing crisis.  Say goodbye to loans with terms greater than 30 years.  No more negatively amortizing loans.  Balloon payments are a thing of the past.  Fees and points cannot cost more than 3% of the loan.  On the underwriting side borrowers cannot have a debt-to-income ratio above 43% meaning they cannot spend more than 43% of their monthly income paying total (not just mortgage) debt.

Lenders following the underwriting criteria set forth in part #2 of the new rule and lending to “prime” (read:  creditworthy) borrowers will enjoy strong legal protections.  They get the benefit of the doubt of properly assessing the borrower’s repayment ability.  A borrower’s only legal recourse is challenging whether the loan was truly “qualified.”

Lenders making loans to “subprime” borrowers (read:  deadbeats) won’t enjoy the same strong legal protections.  Borrowers will be able to argue that even though the loan fit “qualified” terms the lenders should have nonetheless determined that the borrowers couldn’t truly afford the loan.  The Nanny State lives on!