WASHINGTON — Richard Cordray wants lenders to adhere to the most basic tenet of banking: making sure borrowers can repay. Getting them to agree on how is proving tougher.

The director of the Consumer Financial Protection Bureau is aiming to discourage lenders from making home loans with risky features and outlining steps they must take to verify borrowers’ finances, as part of the “qualified mortgage” or QM regulation. Banks that follow the guidelines will gain legal protection against borrower defaults.

“Here’s what should be the least surprising lending advice you’ve ever heard: If you are going to lend money, you should probably care about getting paid back,” Raj Date, the agency’s deputy director, said in a recent speech in Los Angeles.

The rule, which may be released as soon as next month, is dividing the banking industry, with the largest mortgage firms – such as Wells Fargo & Co. and Bank of America – siding with some consumer groups that the provision should allow certain lawsuits. Trade groups whose members include smaller lenders are holding out for a version that would protect bankers entirely from being sued, arguing that without the provision, home loans will be costlier and harder to obtain.

The big banks consented to a weaker standard of legal protection in exchange for a broad definition of the types of permissible mortgages in the new rule, according to a March 7 letter to Cordray from the Clearing House Association, which represents the largest lenders. This step would “combine prudent lending with less litigation, benefiting homeowners, investors and lenders alike,” according to the letter.

To obtain legal protection, a lender would have to meet underwriting standards such as verifying a borrower’s income and assets. Qualifying loans also couldn’t have interest-only payments or include fees and points totaling more than 3 percent of the loan amount.

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Cordray has called the regulation, required by the 2010 Dodd-Frank Act, “one of our most important rule-makings,” four years after home loans triggered the worst financial crisis since the Great Depression. It’s part of a broad overhaul of housing finance by federal agencies that will eventually include legislation overseeing mortgage servicing, securitization and restructuring the government role.

Mortgage originations in the first quarter rose 5.3 percent to $318 billion from the same period last year, according to Mortgage Bankers Association estimates, as homeowners took advantage of mortgage rates near record lows to refinance.

Once the rule goes into effect, lenders are expected to originate most of their loans according to the new standards to gain legal protection from the kind of lawsuits and “putbacks” that have cost banks billions in the wake of the mortgage crisis. The additional legal protections will help banks compensate for lost revenue from higher fees or interest-only mortgages.

In the years leading up to the financial crisis, banks increasingly made loans with high fees and adjustable terms that borrowers wouldn’t be able to repay, requiring them to refinance after a few years. When housing prices dropped, many defaulted instead.

“This rule is aimed directly at the core deficiencies in the mortgage market that produced unsustainable loans, an inflated housing market, and resulting widespread economic hardship,” Americans for Financial Reform, a coalition of consumer advocacy groups, wrote Cordray in an April 18 letter.

Consumer groups are pushing to prevent the rule from providing total protection for lenders. They want to ensure homeowners or bond investors would still be able to sue banks if they could prove lenders didn’t act in good faith.

The rule could influence the volume and profitability of mortgage lending, particularly to lower-income borrowers.


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