On January 10, 2013, the Consumer Financial Protection Bureau (CFPB) released a final rule implementing the Ability-to-Repay (ATR) requirement of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act; P.L. 111-203 ). The final rule is effective January 10, 2014, one year after it was issued. Section 1411 of the Dodd-Frank Act states that, no creditor may make a residential mortgage loan unless the creditor makes a reasonable and good faith determination based on verified and documented information that, at the time the loan is consummated, the consumer has a reasonable ability to repay the loan, according to its terms, and all applicable taxes, insurance (including mortgage guarantee insurance), and assessments. As discussed later in this report, lenders can comply with the statute in different ways, one of which is by originating "qualified mortgages," certain mortgages that meet criteria laid out in the ATR rule. A qualified mortgage (QM) provides additional legal protections for a lender that the other options do not afford. Some observers and mortgage market participants have expressed concerns that, because of the additional legal protection, some lenders will only originate mortgages that receive QM status. The scope of the QM definition, therefore, could affect who can qualify for a mortgage. This report summarizes the ATR rule and analyzes the potential effects it may have on the mortgage market. The next section provides background information on the perceived problems in the mortgage market that motivated the ATR requirement. When a potential borrower applies for a mortgage, a lender underwrites or evaluates the borrower to determine whether a loan should be extended and on what terms. The underwriting process typically involves the lender examining a borrower's income, assets, credit history, and other factors that may affect a lender's ability to recover the amount loaned. Some studies found that underwriting criteria loosened in the mid-2000s while house prices were rising. In particular, some lenders accepted loan applications with little or no documentation to support what was in the applications. Rather than relying on a borrower's verified income or assets to decide whether to extend a loan, some lenders relied on the underlying value of the house to justify offering a mortgage, a process known as collateral-dependent lending. In a mortgage, the borrower pledges the house as collateral; if the borrower is unable to repay the mortgage, the lender can sell the house to recover some or all of the amount of the mortgage debt outstanding. When house prices started to fall and the economy weakened in 2007, foreclosure rates increased significantly, especially for loans with little or no documentation of borrower income or assets. In response to increasing foreclosure rates, the Federal Reserve Board issued a rule in 2008 that prohibited lenders from originating a "higher-priced mortgage" without assessing the borrower's ability to repay the loan and verifying the borrower's income and assets. A first-lien mortgage was deemed to be higher-priced if the annual percentage rate exceeded 1.5 percentage points above the average prime offer rate, which is an estimate of the market mortgage rate based on a survey of rates. When issuing the rule, the Federal Reserve noted that the "rule's definition of 'higher-priced mortgage loans' will capture virtually all loans in the subprime market, but generally exclude loans in the prime market." The Federal Reserve's 2008 ability-to-repay rule enhanced the prior approaches to consumer protection that generally emphasized disclosure to borrowers. The ATR requirements in the Dodd-Frank Act are similar to the Federal Reserve's 2008 rule but expand the ATR requirements to a broader portion of the mortgage market, not just higher-priced mortgages. The Federal Reserve issued the proposed rule implementing the Dodd-Frank Act's ATR requirements in 2011 before the authority to issue the final rule was transferred to the CFPB. In issuing the final rule, the CFPB stated, "a primary goal of the statute was to prevent a repeat of the deterioration of lending standards that contributed to the financial crisis." The next section will explain the CFPB's January 2013 final rule. Prior to offering a borrower a mortgage that is subject to the rule, the ATR rule will require a lender to determine, based on documented and verified information, that the borrower has the ability to repay the loan. Failure to comply could result in a lender having to pay damages to a borrower who brings a lawsuit and claims that the lender did not follow the ATR rule. The final rule provides six methods for lenders to comply: (1) the General ATR Option, (2) the Standard Qualified Mortgage, (3) the Temporary Agency/GSE QM Option, (4) Balloon Mortgages in Rural or Underserved Areas, (5) the Temporary Small Creditor Balloon-Payment QM, and (6) the Small Creditor QM. The different compliance options afford lenders different levels of protection in the event that a borrower brings a lawsuit against a lender. In addition, lenders may be exempt from the ATR rule in certain instances. The compliance options and exemptions are described below. Lenders can satisfy the ATR rule through the General ATR Option. The General ATR Option requires lenders to consider at least eight criteria: 1. current or reasonably expected income or assets; 2. current employment status; 3. the monthly payment on the covered transaction; 4. the monthly payment on any simultaneous loan; 5. the monthly payment for mortgage-related obligations (e.g., taxes and insurance); 6. current debt obligations, alimony, and child support; 7. the monthly debt-to-income ratio or residual income; and 8. credit history. Unlike the qualified mortgage compliance options described in the next sections, the General ATR Option does not have restrictions on mortgage product features. Lenders, in most cases, must verify the eight criteria using reasonably reliable third-party records, such as a borrower's tax return, to verify income. The requirement that lenders verify the criteria using third-party records "effectively prohibit(s) no documentation and limited documentation loans that were common in the later years of the housing bubble." If a borrower sues a lender claiming the lender did not verify the borrower's ability to repay, the "borrower will bear the burden of proof for establishing a violation." Unlike the qualified mortgage option described below, mortgages that comply with the rule through the General ATR Option will not provide the lender with a "presumption of compliance" in the event an action is brought against it. Consequently, lenders could be exposed to additional legal risk if they originate non-qualified mortgages. Rather than complying through the General ATR Option described above, a lender could also comply by originating a "qualified mortgage." A qualified mortgage must satisfy certain underwriting and product-feature requirements. For underwriting requirements, the borrower's total debt-to-income (DTI) ratio cannot be greater than 43%. In addition, the borrower's monthly payment must "be calculated based on the highest payment that will apply in the first five years of the loan." With regard to product-feature restrictions, a QM cannot have A lender that originates a QM is entitled to a "presumption of compliance" with the ATR requirement, but the type of presumption of compliance and the amount of legal protection the lender receives depends on the mortgage interest rate. The CFPB will publish the average prime offer rate (APOR), an estimate of the market mortgage rate based on a survey of rates. A QM with an annual percentage rate (APR) less than 1.5 percentage points above the APOR for a first lien or less than 3.5 percentage points above the APOR for a subordinate lien qualifies for a safe harbor , a conclusive presumption of compliance with the ATR requirement. Mortgages that qualify for a safe harbor are referred to by the CFPB as prime mortgages. Mortgages above the thresholds that otherwise meet the QM requirements are deemed to be "higher-priced covered transactions" and qualify for a rebuttable presumption of compliance. The CFPB refers to QMs receiving a rebuttable presumption as subprime loans. A safe harbor QM has a conclusive presumption of compliance. If a borrower with a prime mortgage sues a lender, the court would need to find that the mortgage is not actually a QM because it fails to meet the necessary underwriting or product feature requirements for the borrower to win his case. "If a court finds that the loan met the QM requirements and was not higher-priced, the consumer would lose this claim." Some lenders may choose to have a larger percentage of their mortgages be prime mortgages to take advantage of the safe harbor. If a borrower has a mortgage that is higher-priced, the borrower could rebut the presumption that the lender complied with the ATR rule. Similar to the safe harbor QM, a borrower could win his case if the court finds that the mortgage was not actually a QM. In addition, if the mortgage is otherwise a QM (meets the other underwriting and product feature requirements), the subprime borrower could win his case if the court finds that "the creditor did not make a reasonable and good faith determination of the consumer's repayment ability at the time of consummation." The borrower could win if, for example, the mortgage payment and other recurring payments that the borrower must make and that the creditor was aware of (such as alimony or child support payments) did not leave the borrower with sufficient residual income or assets to meet living expenses. The CFPB "determined that the bifurcated approach in which only higher-priced covered transactions provide the consumer with the opportunity to rebut the presumption of compliance best balances the concerns of costs, certainty, and consumer protection."