The effect of loose lending during the last housing boom was abundantly clear: Nearly 8 million U.S. homes fell into foreclosure. The response was a slew of new lending rules under the Dodd-Frank financial reform law, and the result was a credit lockdown that continues today, nearly five years after the legislation was enacted.
“For lenders this is all about paperwork, verification and doing a lot of the grunt work that was ignored or passed over before the crisis,” said Jaret Seiberg, a managing director at financing firm Guggenheim Securities.
The rules fill thousands of pages and have cost lenders millions of dollars in labor and software to revamp their systems in compliance, but at face value, they’re pretty simple. Highly risky loan products, like negative amortization mortgages, are now banned. Borrowers must document their employment and debt levels. Lenders must disclose all the costs involved in each loan, and, perhaps most important, lenders must verify a borrower’s ability to repay the mortgage.
That last one may sound ridiculous, but it was the fundamental reason for the financial crisis in housing. Borrowers were given loans they could never repay.