The Dodd-Frank Act Explained: How Does It Affect Mortgages?

The Dodd-Frank Wall Street Reform and Consumer Protection Act was enacted in the wake of the 2008 financial crisis to provide stronger financial protections for consumers. The federal law was designed to counter unfair practices in the mortgage industry, and to stabilize the housing market for the benefit of the overall economy. Though parts of the law have been rolled back, it continues to affect the mortgage approval process for aspiring homebuyers.

What Is the Dodd-Frank Act?

The Dodd-Frank Act is a federal law enacted in 2010 in response to the financial crisis of 2008. It imposed reforms on lenders to prevent unfair, deceptive, or abusive lending practices, as well as excessive risk-taking by Wall Street firms. The law is named after its sponsors: Democrats Barney Frank in the House of Representatives, and Chris Dodd in the Senate.

The law was meant to stabilize the U.S. financial system and better safeguard consumers. Among its provisions, the law changed the income verification process to prevent borrowers from being approved for home loans they could not afford. It also tried to level the playing field between middle-class mortgage borrowers and those taking out jumbo mortgage loans by limiting fees on mortgage-related services.

5 Ways the Dodd-Frank Act Helps Protect Homebuyers

So, exactly what did the Dodd-Frank Act do? Here’s a Dodd-Frank Act summary of how the law changed the mortgage process to safeguard homebuyers.

1. It bans unfair, deceptive, and abusive lending practices

The Dodd-Frank Act prohibits providers of consumer financial products and services from engaging in predatory practices, or those that are considered unfair, deceptive, or abusive.

Here’s how the law defines each standard:

• An unfair act or practice is likely to cause monetary harm to the consumer, which they cannot reasonably avoid. The harm caused must not be outweighed by any offsetting benefits.
• A deceptive act or practice likely misleads the consumer on important information about their loan. When determining if an act is deceptive, it must be interpreted from a reasonable consumer’s perspective.
• An abusive act or practice interferes with a consumer’s ability to understand the terms and conditions of a product or service. It takes advantage of a borrower’s unfamiliarity with the process, interferes with their ability to protect their best interests, or encourages reliance on others to act in their interest.

2. It authorizes the CFPB to ensure consumers are treated fairly

The Dodd-Frank Act created the Consumer Financial Protection Bureau to consolidate in one agency the oversight of consumer financial protections. Those responsibilities previously were divided between multiple federal agencies. The CFPB also was given a mandate to encourage consumer transparency and consistent enforcement.

For example, the CFPB program called Know Before You Owe helps homebuyers understand their mortgage options, shop for the right loan, and avoid costly surprises at closing. It simplified loan disclosures into two standardized documents — the loan estimate and the closing disclosure — and required them to be provided to borrowers in a timely fashion. This makes it easier for consumers to understand the exact costs involved when getting a mortgage.

3. It bans balloon payments for qualified mortgages

A balloon payment is a lump sum that typically is due at the end of the loan term. Mortgages with a balloon payment may offer greater financial flexibility for borrowers in the beginning of the repayment schedule. But they become more risky as the balloon payment approaches for borrowers who may struggle to afford the final lump-sum payment. Failing to make the balloon payment puts borrowers at risk of defaulting on their mortgage, and in danger of foreclosure right at the end of their loan term.

The Dodd-Frank Act eliminates balloon payments on qualified mortgages, which are loans that meet specific standards that make them more stable for borrowers and lenders alike. Only certain qualified mortgages can be sold on the secondary mortgage market, and lenders receive legal protections when they assess and confirm that borrowers can repay their loans. This discourages lenders from making loans with balloon payments.

4. It deters steering practices

Steering is when lenders or agents push customers toward or away from buying in certain neighborhoods because of their race, religion, ethnicity, sexual orientation, or other protected characteristics. They also may steer buyers into specific loan products or terms, usually because they serve to benefit the lender or broker — not necessarily because those products are the best choice for the borrower.

Thanks to the Dodd-Frank Act, mortgage incentives that encourage steering were prohibited. The law also introduced unofficial fiduciary duties of care and loyalty that require lenders to act in the best interests of their borrowers. Lenders are prohibited from directing borrowers to a particular mortgage without considering their qualifications or ability to repay the loan. They also may not direct borrowers to a mortgage that would result in better compensation for the lender unless the transaction is the best option for the borrower as well.

5. It requires escrow accounts for certain loans

Most homeowners use an escrow account to pay their homeowners insurance premiums and property taxes. The estimated annual cost of these essential fees is prorated and added to the monthly mortgage payment for the principal and interest on the loan.

Escrow accounts were in most cases optional, and homeowners could take on the responsibility for paying those bills on time and in full. To avoid borrowers without escrow failing to pay those bills, the Dodd-Frank Act directed lenders to require escrow accounts for certain home loans for at least five years. These accounts, which are required on certain “higher-priced mortgage loans,” help ensure that borrowers have enough funds set aside to pay their property taxes and homeowners insurance when they are due.

Controversies, Criticisms, and Rollbacks

Dodd-Frank mortgage regulations have been heavily criticized for increasing the regulatory burden on lenders in a way that increases the cost for consumers. This often leads to higher mortgage origination costs, which generally are passed on to borrowers.

“Almost all areas of home lending immediately increased their costs to cover the additional audits, regulations, employees needed, and reporting the acts required,” says Jerry Koller, a real estate broker in Orange County, California.

Another criticism is that the Dodd-Frank Act led to stricter lending standards. While this was part of the law’s intent, it also makes it more difficult for borrowers to get a mortgage if they have a limited credit history, a less-than-perfect credit score, or irregular income. Additionally, these requirements and standards have been criticized for making the lending process more time-consuming and complicated.

Of course, other critics say the legislation didn’t go far enough. They claim the law focuses too much on banks and not enough on other areas of the financial system, many of which also played a significant role in the 2008 financial crisis.

After the Dodd-Frank Act was enacted in 2010, the first regulatory rollback was approved in 2018. Among other changes, it freed thousands of smaller banks from the strict rules imposed in response to the financial crisis. Critics of the rollback highlighted how it would undermine important protections for homebuyers, and that expanding access to credit would increase financial risk to certain consumers.

FAQ: How the Dodd-Frank Act Affects Mortgages

Here are answers to common questions about the Dodd-Frank Act.

The Bottom Line on How the Dodd-Frank Act Affects Mortgages

The Dodd-Frank Act of 2010 brought sweeping changes to the financial regulatory system. It increased consumer protections by barring lenders from unfair, deceptive, and abusive practices, and created a new watchdog agency to help protect consumers. Though post-Dodd-Frank mortgage lending rules have tightened up, and loans have become more costly as a result, the law’s provisions remain in place to protect homebuyers.

Stephanie Colestock contributed to the reporting of this article.