Court ruling on payday lending could impact mortgage markets

A court tossed out a regulation written by the Consumer Financial Protection Bureau for payday lenders last week, saying the agency’s funding was unconstitutional and that it, therefore, lacked the ability to curb the industry.

The U.S. Court of Appeals for the Fifth Circuit voided a CFPB rule that prohibited payday lenders from debiting the accounts of customers who miss a payment without getting their consent first. While the ruling applied just to that regulation, financial service attorneys say it muddies the agency’s authority and has the potential to upend all of its rules.

“The Fifth Circuit’s ruling potentially calls into question every single rule, guidance and order that the CFPB has issued — as they all trace their origins to the CFPB’s unconstitutional self-funding structure,” regulatory attorneys Anthony DiResta and Luis Garcia of Holland & Knight wrote in a note to clients Tuesday.

If the agency’s legal authority is undermined, it could have a profound affect on home lending markets — an industry that’s prone to disruption when laws are murky, especially as interest rates rise.

“Anything that disrupts the mortgage market is potentially going to make it even harder for homebuyers to qualify for a loan,” said Patricia McCoy, a professor of law at Boston College.

McCoy points to Georgia after the state passed a law in 2002 intended to protect consumers from predatory loans by allowing them to seek punitive damages from the loan originator and whoever bought the loan. That extended the potential damages to the Wall Street banks as well as mortgage investors Fannie Mae and Freddie Mac.

Top credit-rating agencies refused to rate residential mortgage-backed securities pools containing loans that originated in Georgia, which had a chilling effect on the MBS market. Fannie and Freddie, which buy mortgages and package them as securities to sell to investors, stopped buying mortgages in the state. The next year, the Georgia legislature changed the law, pulling back the liability provisions.

“The Fifth Circuit’s decision threatens to paralyze mortgage lending in Mississippi, Louisiana, and Texas because lenders will lose certainty about what law applies to future mortgages that they make,” McCoy said, referring to the states within the Fifth Circuit. She was part of the original leadership team at the CFPB during the Obama administration.

Established after the 2008 financial crisis, the CFPB created a series of rules for the mortgage industry, including standards for a ‘qualified mortgage’ based on a borrower’s ability to repay a loan. Those two rules give mortgage investors and lenders legal protection from borrowers who claim they were deceived into taking out a loan they couldn’t afford so long as it meets that standard.

If the Fifth Circuit decision is upheld, it could call into question those…