With multiple provisions and offering more than eight hundred pages of text, the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) of 2010 represents some of the most sweeping financial reform legislation enacted since the Great Depression.
The Act created new agencies and mandated action from existing agencies to broaden consumer protection rules. It did so by restricting the activities of lending companies and banks.
Why Was the Dodd-Frank Act Needed?
Until 2007, lax regulations led to extremely risky lending practices, which caused a housing sector bubble that ultimately burst and drove the global crisis, the need for public bailouts of financial institutions, and the recession.
In the fall of 2008, the financial crisis of a scale and severity not seen in generations left millions of Americans unemployed and resulted in trillions in lost wealth. The broken financial regulatory system was a principal cause of that crisis. It allowed large parts of the financial system to operate with little or no oversight and some predatory mortgage lenders to use hidden fees and fine print to take advantage of consumers.
Washington did not have the authority to monitor or constrain risk-taking at the largest firms properly. When the crisis hit, they did not have the tools to break apart or wind down a failing financial firm without putting the American taxpayer and the entire financial system at risk.
The institutions considered responsible for the 2007–2008 financial crisis included banks, insurance companies, investment banking firms, mortgage lenders, and credit rating agencies.
The most far-reaching Wall Street reform in history, Dodd-Frank, was designed to prevent the excessive risk-taking that led to the financial crisis. The law also provides common-sense protections for American families, creating a new consumer watchdog to prevent mortgage companies and pay-day lenders from exploiting consumers and to penalize predatory lending practices in the mortgage industry.
What are the Requirements of the Act for Residential Mortgages?
Concerning consumers seeking residential mortgage loans, the law applies to mortgage originators. Mortgage originators are in the business of financing loans for residential homes. The Dodd-Frank Act defines a mortgage originator as any person who receives compensation for offering a mortgage loan, assists a consumer in applying for such loans, or negotiates the terms for those loans. A residential mortgage loan is defined generally as being one secured by a mortgage, deed of trust, or equivalent on a home.
The Act created an independent agency to set and enforce clear, consistent rules for the financial marketplace. The Consumer Financial Protection Bureau (CFPB) sets new, clear rules of the road. The CFPB was tasked with preventing predatory mortgage lending and helping consumers understand the terms of a mortgage before agreeing to it.
The mountain of forms needed for a regular mortgage can be overwhelming, and many brokers were taking advantage of that confusion to give borrowers loans they didn’t need or couldn’t afford. The CFPB launched a program called “Know Before You Owe,” to combine two federally required mortgage disclosures into a single, simpler form that makes the costs and risks of the loan clear and allows consumers to compare shops.
The CFPB provides ongoing federal oversight of non-bank companies and banks in the mortgage industry to protect borrowers from deceptive, unfair, or other illegal mortgage lending practices. The CFPB also governs other types of consumer lending, including credit and debit cards, and addresses consumer complaints. It requires lenders, excluding automobile lenders, to disclose information in a form that is easy for consumers to read and understand. Such an example is the simplified terms now on credit card applications.
The Act establishes and clarifies certain mortgage underwriting procedures as well. For example, the mortgage provider must make a reasonable and good faith determination about a consumer’s ability to repay a mortgage loan. The Act limits prepayment penalties and fees to encourage homeowners to get out from under their mortgage as quickly as possible. It also prohibits some risky lending maneuvers. Finally, it requires lenders to keep records of their compliance with these regulations.
Further, the Dodd-Frank Act requires mortgage loan creditors to:
- Limit the cost of loan origination
- Lengthen mandatory escrow time
- Provide applicants with free copies of appraisals made in connection with a qualified loan application rather than requiring the borrowers to ask for them
- Streamline loan servicing documentation requirements
- Correct documentation errors based on information provided by borrowers
- Provide forced-placed insurance protection for borrowers
- Provide certain information when requested by borrowers
- Adhere to rules that shape the content and timing of disclosures to consumers about their variable-rate transactions
- Establish reasonable policies and processes under the Act’s consumer protection objectives
- Provide loss mitigation information to delinquent borrowers and satisfy procedures for reviewing applications for mitigation options
- Educate consumers about their rights by providing loan counseling in certain situations
Does the Law Establish Criteria for Determining Mortgage Repayment Ability?
The law outlines some helpful criteria that the mortgage creditor should consider when fulfilling its obligation to analyze a consumer’s ability to repay a loan carefully. This assessment must be conducted before the originator issues a mortgage loan. Those criteria include a review of the consumer’s:
- Employment status
- Current income
- Expected income
- Current financial obligations
- Debt-to-income ratio
- Record for paying financial obligations, which comes from reviewing the credit history
- Other financial resources.
The consumer’s income can be verified by reviewing the following Internal Revenue Service–accepted documents:
- Form W–2
- Tax returns
- Payroll receipts
- Bank records
Why is there Debate Regarding the Dodd-Frank Act?
Supporters of the Act believe it provides much-needed restrictions on financial institutions and greater consumer protections to help avoid another recession. Like any other law, the Dodd-Frank has also been criticized. It has been described as unnecessarily complex and burdensome for investors, contributing to a sluggish economy.
What is the Latest on the Dodd-Frank Act?
Since its enactment, there have been efforts to roll back some of the provisions of the Dodd-Frank Act, including proposed legislation to raise oversight thresholds, reduce financial reporting, and ease conditions of bank stress tests. An executive order was issued in February 2017 to reevaluate the Act, followed by new legislation in May 2018.
The new legislation carves out exemptions for meeting the consumer’s ability to repay rule (i.e., income verification criteria, as described above) and increases consumer access to mortgage loans by easing regulatory restrictions for certain lending institutions (including community banks and credit unions).
Additionally, the following are some of the intended effects of the amendment to the Act:
- Increased protection for access to consumer credit by requiring credit reporting agencies to provide fraud alerts and to place security freezes on consumer files
- Modification of the requirement that lenders provide appraisals in rural areas
- Modification of the escrow requirements
- Increased foreclosure protections
Should I Consult an Attorney for Issues with the Dodd-Frank Act?
Many still regard the Dodd-Frank Act as a much-needed regulatory reform that has successfully put a check on banks and other financial institutions that take irresponsible lending risks and protect consumers of residential mortgage loans. Some of the provisions of the Act have been rolled back by recent legislation.
If you are a lender, investor, or mortgage consumer, you can learn more about how the Act and its past and most recent modifications affect you by consulting a qualified mortgage attorney.