Final answer:
The Dodd-Frank Act incentivizes banks to only offer mortgages that they believe will not default through stricter underwriting standards and risk retention requirements.
Step-by-step explanation:
The Dodd-Frank Act, also known as the Dodd-Frank Wall Street Reform and Consumer Protection Act, includes provisions aimed at incentivizing banks to only offer mortgages that they believe will not default. One key provision is the Qualified Mortgage (QM) rule, which imposes stricter underwriting standards for mortgages. To qualify for QM status, the loan must meet certain criteria, such as having a reasonable debt-to-income ratio and not having risky loan features.
Additionally, the Dodd-Frank Act requires lenders to retain a portion of the risk associated with the mortgage loans they originate. This is known as the risk retention requirement. By requiring lenders to retain a stake in the loans they make, the Dodd-Frank Act aligns their interests with that of the borrower, as they have an incentive to ensure that the loans they make are more likely to be repaid.
In summary, the Dodd-Frank Act incentivizes banks to only offer mortgages that they believe will not default by imposing stricter underwriting standards and requiring lenders to retain a portion of the risk associated with the mortgage loans they originate.