Congress enacted the Dodd-Frank Act in 2010 in response to the mortgage crisis that led to what some economic professionals are calling America's Great Recession.
While I'm not an economics professional, I did watch the cause and effect of lending practices that led to this recession. "Just because you can, doesn't mean you should." should have been included in lenders visits with prospective borrowers. Lending practices were so loosey-goosey that fogging a mirror pretty much meant you could borrow money. And as described in more detail below, allowing interest only mortgages may have been great for the buyer for the first few years, but once it all hit the fan, the plain and simple of it was the buyer purchased too much house, one they realistically couldn't afford. The Iowa City area was rather protected - and I give huge credit to our local lenders. They are very educated people, and they cared about the borrowers by giving good advice, and not setting folks up for failure. Just because they could get that loan didn't mean that they should get that loan. Receiving great advice kept our local market from tanking the way other communities did. The fallout for us was when people moved here from an affected community, and they couldn't buy here because they couldn't sell there. Eventually, every home does sell, and people were then able to move forward.
The two parts of the Dodd-Frank Act that apply closely to home buyers are the Ability-to-Repay (ATR) and Qualified Mortgages (QM).
A Qualified Mortgage is a category of loans that have certain, more stable features that help make it more likely that borrowers will be able to afford their loan. These loans do not allow certain risky features like an interest-only period when no money is applied to reduce the principal; negative amortization that would allow the mortgage balance to increase; and, "balloon payments" at the end of the loan that are larger than the normal periodic payments.
A debt-to-income ratio of less than or equal to 43% has been established to provide a limit on how much of a borrower's income can go toward total debt including the mortgage and all other monthly debt payments. However, the Consumer Finance Protection Bureau believes these loans should be evaluated on a case-by-case basis and in some cases, can exceed 43%.
There is a limit for up-front points and fees the lender can charge.
By showing that the lender made an effort to be certain that the borrower has the ability to repay the loan, the lender in turn, receives certain legal protections. Underwriting factors considered by the lender include:
current or reasonably expected income or assets
current employment status
the monthly payment on the covered transaction
the monthly payment on any simultaneous loan
the monthly payment for mortgage-related obligations
current debt obligations, alimony, and child support
the monthly debt-to-income ratio or residual income
credit history
For more information, see the Consumer Financial Protection Bureau fact sheet ... protecting consumers from irresponsible mortgage lending.