New Interpretation of the “Ability to Pay Rule” and a Surviving Family Member

“Pitt’s income tax” by James Gilray (Life time: 18th century) – Original publication: Cartoon Immediate Source

Losing a close friend or family member can be very difficult on an emotional level, however it can also be challenging from an estate management perspective as well.  In many cases, surviving loved ones must quickly learn the financial and legal ramifications involved with real property included in an estate.  To ensure a more seamless transition process is implemented when these life situations occur, the government has been devising new rules for lending institutions.

Prior to the loan crisis, many lenders’ origination channels did not institute conservative practices to derive whether a borrower could actually repay the loan. Therefore, Congress implemented “The Dodd Frank Wall Street Reform and Consumer Protection Act” on July 21, 2010 to make substantial changes to financial regulations in efforts to protect the American consumer by giving authority to the Consumer Financial Protection Bureau to impose new rules. 

At the start of 2014, Congress passed a new law entitled the “Ability to Pay” rule, to protect consumers from creditors and mortgage lenders by requiring mortgage institutions to determine a borrower’s ability to repay a loan.  If the Lender determines that the potential borrower does not have the ability to repay the loan, then they cannot legally issue the loan. While the rule was required by Congress in response to the financial crisis and nationwide foreclosure epidemic, the Consumer Financial Protection Bureau clarified it on July 11, 2014 regarding circumstances when a borrower on a mortgage of real property dies. In these cases, an heir (successor owner) may seek to be added as an obligor or substituted for the current obligor on an existing mortgage without initiating the Ability to Pay Rule before acquiring ownership.

Oftentimes when real property in an estate is transferred from a deceased owner to a new owner, a debt obligation on the property is still outstanding that is owed to the lender. While the interpretative ruling by the Bureau of Consumer Financial Protection primarily addresses situations where an obligor has passed and left the outstanding debt to a surviving spouse or child, it also may be applicable in other situations: “separation or divorce; after a transfer from living parents to children; and a transfer to an inter-vivos* trust of which the consumer is the beneficiary.”1

To ensure the lender does not decline the transfer of real property, the new interpretation of the rule clearly indicates that adding the heir to the mortgage title does not activate the Ability to Pay Rule requirements.  The “creditor’s written acknowledgement of the successor as obligor is not subject to the bureau’s Ability to Repay Rule, because such a transaction does not constitute an assumption as defined by Regulation Z”. Regulation Z protects mortgage consumers from unfair practices relating to compensate mortgage brokers and other originators.

Mortgage servicers, whom are companies that may or may not be affiliated with the original lender, administer the loan until it is paid off, are now required by the “Ability to Pay” law to proactively collect payments on behalf of lenders and creditors from mortgage borrowers.  Servicers must implement their process and procedures to quickly identify and communicate with surviving family members or other parties who have a legal interest in a property. If an heir is added to a mortgage, there are financial ramifications that may require the heir to attempt to modify the loan in order to retain the property. As such, the new interpretation of the regulation will give rights to the heir of real property to not only be added to the mortgage, but the ability to modify the mortgage terms, without the Ability to Pay Rule preventing such occurrence.

*inter-vivos – a legal term referring to a transfer or gift made during one’s lifetime, as opposed to a testamentary transfer (a gift that takes effect on death).

¹Bureau of Consumer Financial Protection 12 CFR Part 1026 [Docket No. CFPB-2014-0016).  RIN 3170-ZA00.  Billing Code: 4810-AM-P