The Dodd-Frank Wall Street Reform and Consumer Protection Act was passed in the wake of the 2008 financial crisis, imposing stricter rules on banks and the mortgage industry and providing stronger financial protections for consumers. Today, first-time homebuyers and consumers in general benefit from Dodd-Frank regulations.
Here’s what you should know about the Dodd-Frank Act:
- What Is the Dodd-Frank Act?
- 5 Ways the Dodd-Frank Act Helps Protect Homebuyers
- Dodd-Frank Act FAQ
- The Bottom Line on Dodd-Frank Regulations
What Is the Dodd-Frank Act?
The Dodd-Frank Act is a law that was passed in response to the financial crisis of 2008. It aimed to reform areas of the financial regulatory system that allowed for unfair, deceptive, or abusive lending practices as well as excessive risk-taking by Wall Street firms. The Dodd-Frank regulations were meant to create greater stability in the U.S. financial system and better safeguards for consumers.
Key takeaways of the Dodd-Frank Act explained
- Sweeping changes: The legislation represented extensive reforms to the parts of the financial system believed responsible for the crisis.
- New watchdog agency: The Consumer Financial Protection Bureau was created to set and enforce federal rules for financial companies, and to help simplify consumer information surrounding the costs of mortgages, overdraft programs, credit cards, student loans, and more.
- Stronger protections for consumers: Due to the law, there’s ongoing federal oversight of banks and other financial companies to prevent certain practices that are unfair, deceptive, or abusive.
- Regulations on bank investments: Under the Dodd-Frank Act, the Volcker rule prohibits banks from short-term proprietary trading, which is when banks invest their own funds and take on risk to increase their profits. The rule also limits banks in terms of investing in hedge funds and private equity funds.
- More whistleblower protections: The law prohibits retaliation against whistleblowers by their employers, and requires the Securities and Exchange Commission to provide monetary awards to whistleblowers in eligible cases.
Controversies and rollbacks
Dodd-Frank regulations have been subject to criticism. For one, the law ultimately increased the costs of banking and borrowing money for consumers.
“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. Essentially, many Dodd-Frank compliance costs were passed on to consumers.
Others say the legislation wasn’t far-reaching enough, focusing too much on banks and insufficient attention on other areas in the financial system.
And after the Dodd-Frank Act passed in 2010, the first regulatory rollback was approved in 2018. Among other changes, it freed thousands of smaller banks from the strict rules imposed after the 2008 financial crisis. Critics of the rollback highlighted how it would undermine important protections for homebuyers, and that expanded access to credit would increase financial risk to consumers.
5 Ways the Dodd-Frank Act Helps Protect Homebuyers
Here’s a summary of how Dodd-Frank regulations help safeguard homebuyers.
1. No unfair, deceptive, or abusive lending practices
Under the Dodd-Frank Act, it’s illegal for providers of consumer financial products and services to engage in practices that are unfair, deceptive, or abusive.
This is 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 also must not be outweighed by any offsetting benefits.
- A deceptive act or practice is likely to mislead the consumer regarding important information. The interpretation of the act or practice must be considered 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 their lack of understanding, inability to protect their best interests, or reliance on others to act in their interests.
2. The CFPB helps ensure consumers are treated fairly
The Consumer Financial Protection Bureau was established by the Dodd-Frank Act. Previously, authority on consumer financial protection had been spread between seven federal agencies. Creating the CFPB consolidated that authority with the goal of consistent enforcement across the market.
One of the CFPB’s programs, the “Know Before You Owe” mortgage initiative, is meant to assist homebuyers with understanding their mortgage options, shopping for the right loan, and avoiding costly surprises at closing. It simplified four disclosure forms into two — the loan estimate and the closing disclosure — that are easier for consumers to use when getting a mortgage.
3. Balloon payments aren’t allowed for qualified mortgages
A balloon payment is defined as a larger lump-sum payment at the end of the loan term. Mortgages with a balloon payment can come with greater financial flexibility at first. However, they’re risky for borrowers who can’t afford the final lump sum, which could be more than twice as much as the usual monthly payment.
The Dodd-Frank Act prohibited qualified mortgages — which are loans with certain features that are more stable — from including balloon payments. And lenders benefit from extending qualified mortgages. 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.
4. Anti-steering practices
The Dodd-Frank Act made steering incentives unlawful. Lenders are prohibited from directing borrowers to a particular mortgage without considering their qualifications or ability to repay the loan. Additionally, lenders aren’t allowed to direct borrowers to a mortgage that would result in better compensation for the lender, unless the transaction is also in the borrower’s best interests.
5. Escrow accounts are required for certain loans
Monthly mortgage payments don’t just include the principal and interest on the loan. They also cover taxes and insurance.
The Dodd-Frank Act required lenders to create escrow accounts for certain higher-priced home loans and maintain them for at least five years. This helps ensure that borrowers have enough funds to pay for property taxes, homeowners insurance, and mortgage insurance when the time comes.
Dodd-Frank Act FAQ
Here are the answers to a couple of frequently asked questions surrounding the Dodd-Frank Act.
A major factor that led to the subprime mortgage crisis of 2007-2010 was the increased availability of credit to borrowers who would have previously struggled to obtain a mortgage. A rise in subprime lending during the early and mid-2000s fueled an unsustainable period of rising home prices and demand for housing. Higher-risk borrowers started defaulting on their mortgage payments, lenders suffered losses, and the housing market entered a damaging spiral of declining prices and demand.
In the mid-2000s, an investment bank known as Lehman Brothers acquired lenders that focused on subprime loans and made huge investments into mortgage-backed securities. As a result, the firm was particularly vulnerable as subprime borrowers began to default on their mortgages and the housing market started to crash. Although Lehman Brothers was the fourth-largest investment bank in 2008, it was forced to file for bankruptcy. The bank’s collapse contributed to the financial crisis in a major way.
The Bottom Line on Dodd-Frank Regulations
The Dodd-Frank Act represented sweeping changes to the financial regulatory system following the crisis of 2008. It increased consumer protections by barring unfair, deceptive, or abusive practices by lenders, among other reforms, and created a new watchdog agency to help enforce these rules. It’s possible that further rollbacks will be introduced to the law — but in the meantime, homebuyers will likely appreciate the different protections that the Dodd-Frank Act provides.