The U.S. Treasury Department is narrowing an exemption used by some mortgage lenders to offer “no doc” loans. The exemption had allowed certain lenders a way around the Dodd-Frank rules enacted after the financial crisis.
The changes are part of new regulations released late Thursday that govern federally certified lenders known as Community Development Financial Institutions. The new rules, following years of debate, declare that CDFIs, like most other lenders, must consider borrowers’ ability to pay back loans.
Barron’s has reported that California-based Change Company used its exemption from “ability-to-repay” rules to become the nation’s biggest issuer of nonqualified mortgages: loans with features such as interest-only periods and balloon payments.
Other CDFI lenders have also used the no-doc provision to offer loans to borrowers that wouldn’t qualify for mortgages under post-financial crisis underwriting requirements.
The new Treasury Department rules also include enhanced scrutiny for CDFI-certified consumer-loan businesses that charge interest rates above 36% and a prohibition on selling collection rights to charged-off customer debt, according to a fact sheet from Treasury describing the new rules.
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“These baseline standards will stop the CDFI imprimatur from going to institutions that regularly offer predatory loans…or to institutions that issue mortgages without checking applicants’ ability to repay, putting them at risk of avoidable foreclosures,” Andrew Kushner, senior policy counsel at the Center for Responsible Lending, said in a statement.
The Treasury unit that administers the CDFI program, the CDFI Fund, has had an outsize impact in the world of socially-conscious lending. It offers government certification to both nonprofit and for-profit companies that lend to underserved communities.
CDFI certification can attract millions in new investment from banks with community-lending requirements to fulfill, as well as from socially conscious investors.
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In recent years, groups including the Center for Responsible Lending have argued that CDFIs have been misused. In 2017 the CDFI Fund embarked on an effort to revise its certification rules in response to such criticism.
The fund stopped accepting applications in late 2022, soon after it released a version of its new criteria for certifying companies that it described as a near-final draft. It said the process would resume early the following year, after the new rules were finalized.
Industry backlash to the proposed rules, however, prompted the CDFI Fund to postpone the launch of the new criteria while the agency revised them further. The criteria released Thursday are the product of that yearslong process.
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New applicants to the program must meet the revised criteria immediately. Existing CDFIs have until the end of next year to conform with the new rules.
“The revised application was finalized after an extensive process of public engagement that took place over seven years and reflects the careful consideration the CDFI Fund gave to all of the public comments,” said the agency’s acting director, Marcia Sigal. “We believe the revised application strengthens the value and meaning of CDFI Certification.”
Among the biggest changes are new directives that would nudge CDFI mortgage lenders toward considering consumer-protection rules from which they are now largely exempt.
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These rules, enacted as part of the Dodd-Frank reforms in 2010, and implemented by the Consumer Financial Protection Bureau, spell out a specific set of documents that mortgage lenders need to verify a borrower’s ability to repay.
The CFPB in 2014 exempted CDFIs from those regulations, under the premise that they would curtail the ability of community-focused organizations from meeting the lending needs of their low- and middle-income clients.
Since then, some bigger lenders have become certified as CDFIs, and have used the ability-to-repay rule exemption as a selling point.
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Anaheim, Calif.–based Change Lending has promoted the exemption in trade-press and social-media advertisements as an “unfair advantage” for brokers that work with the company. In 2022, it was the nation’s biggest originator of nonqualified mortgages, according to Scotsman Guide, a publisher of mortgage-business data.
In a statement, Change commended elements of the new criteria for CDFI certification, including a revision that streamlines refinance applications for some government loan programs. The firm didn’t address the CDFI Fund’s new rules around assessing borrowers’ ability to pay back loans.
“We continue to review the changes and the impacts they will have on minority and low-income borrowers,” the company said.
Another CDFI, Gilbert, Ariz.–based Champions Funding, also cited its ability-to-repay rule exemption in a prospectus for brokers on its website. Champions didn’t respond to a message seeking comment on the new regulations.
The new rules don’t explicitly bind CDFIs to the ability-to-repay rules, which require that borrowers document income, assets, employment, credit history, and monthly expenses, but they do require at least some of that documentation.
Lenders that don’t consider a borrower’s ability to pay back loans will now be asked for “an explanation of how this otherwise ineligible practice serves a community development purpose and is consistent with a community development mission.”
The “CDFI Fund regards the consideration of a borrower’s ability to pay back a loan a basic principle of responsible financing practices,” the agency says in a question-and-answer document about the changes.
Marc Halpern, chief executive of lender Foundation Mortgage in Miami, says the new requirement will diminish the number of borrowers that qualify for loans from CDFIs.
“Certainly the volume will be reduced,” says Halpern, whose company also specializes in nonqualified mortgages.
Also under the new rules, rates on consumer loans above 36%—with fees calculated as interest—would trigger additional scrutiny and potential removal from the program. Such lenders would be barred, for example, if more than 5% of those high-interest loans default over a 12-month period.
Barron’s has reported that personal lending firm Fig Loans provides mortgages many times that 36% cap. Its website currently advertises rates as high as 211%.
Members of Fig’s leadership didn’t respond to messages from Barron’s.
Jeff Zhou, a Fig co-founder, told the New York Times in 2018 that he founded Fig to give borrowers with poor credit an alternative to payday loans, which are even more expensive.
Some rule changes that had been proposed in last year’s draft of the revisions were removed or relaxed, including a ban on loans with balloon payments.
“The thing that’s so hard about this work is the nuance between what’s helpful and what’s abusive,” says Annie Donovan, a former CDFI Fund director who now leads a CDFI focused on Latino communities. “And that’s where they’re trying to draw the line.”
Write to Jacob Adelman at [email protected]
