A long-awaited rule on suitability and what constitutes a qualified mortgage has been finalized. The rule is expected to protect unsuspecting consumers from overzealous originators who disregard the borrower’s ability to repay the loan in order to generate commissions. But some insiders warn about further tightening in an already frigid credit environment.
The Consumer Financial Protection Bureau said Thursday that it adopted a new rule that requires mortgage lenders to ensure borrowers have the ability to repay their loans.
CFPB Director Richard Cordray said in prepared remarks that the ability-to-repay rule “is a simple, obvious principle that needs to be re-established in the housing market. It is nothing more than the true essence of ‘responsible lending.'”
The regulator said programs like no-document and interest-only loans contributed to the housing market collapse and financial crisis. A gradual deterioration in underwriting standards led to dramatic deterioration in delinquencies and foreclosures.
Cordray explained that reckless lending practices in the run-up to the financial crisis were driven by bad property value assumptions, dysfunctional secondary marketing incentives and broad indifference to the ability of many consumers to repay loans.
The reckless lending era was followed by a credit market environment that is “achingly tight,” according to the director.
“Both periods have hurt individuals and families who simply seek to fulfill the promise of the American dream of homeownership,” Cordray said. “Our goal with the ability-to-repay rule is to make sure that people who work hard to buy their own home can be assured of not only greater consumer protections but also reasonable access to credit so they can get a sustainable mortgage.”
He went on to describe a California borrower who was allegedly victimized by a lender that put him into a loan he couldn’t afford and now faces foreclosures. However, while Cordray pointed his finger at dubious lenders, he did acknowledge that some borrowers “had their eyes open, seeking to ride the wave of rising housing prices.”
Congress responded to the poor lending practices with the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, a law that created the CFPB and empowered it with the authority to oversee mortgage products.
Following “extensive research and analysis,” the CFPB developed the ability-to-repay rule, which will protect consumers from irresponsible mortgage lending and shield them from risky lending programs.
The rule goes into effect on Jan. 10, 2014.
“When consumers sit down at the closing table, they shouldn’t be set up to fail with mortgages they can’t afford,” Cordray said.
The rule requires lenders to review a prospective borrower’s financial information and document the borrower’s assets, sources of income, and all monthly payments and debt obligations. Debt-to-income ratios must be factored into loan approvals. Teaser rates on adjustable-rate mortgages can’t be used in qualification; instead, the highest possible payment during the first five years of the loan need to be used.
“This means that lenders can no longer offer no-doc, low-doc loans, where lenders made quick sales by not requiring documentation, then offloaded these risky mortgages by selling them to investors,” the CFPB said.
Cordray noted that he “firmly” believes that many foreclosures would have been avoided had the ability-to-repay rule been in existence a decade ago.
Lenders can avoid the full underwriting process if they are refinancing a borrower out of a risky mortgage — such as an ARM, an interest-only loan or a negative-amortization loan — to a more stable, standard loan.
According to the CFPB, the ability-to-repay rule does not affect the rights of a consumer to challenge a lender for violating any other federal consumer protection laws.
Mortgage bankers are concerned about the impact that the rule will have on credit availability.
“Our concern has always been that we balance this goal with other housing policy objectives, particularly the objective to ensure the availability of mortgage credit to qualified borrowers,” Mortgage Bankers Association Chairman Debra Still said in a statement from the trade group. “And right now, credit is tighter than at any point we can remember.”
Lenders can comply with the ability-to-repay rule by issuing “qualified mortgages.”
Such loans limit points and fees, including those used to compensate loan originators and mortgage brokers. Points and fees paid by the consumer cannot exceed 3 percent of the loan amount, though “bona fide discount points” are excluded from the limit on prime mortgages.
“The 3 percent cap on points and fees appears to be overly inclusive as it relates to compensation and affiliates,” Still said in MBA’s statement. “Loans with the same interest rate, terms and out of pocket costs should be treated the same under the rule regardless of the organizational structure or business model of the lender.”
MBA is also concerned with the QM’s 150-basis-point spread limit over benchmark rates, which it warns will adversely impact too many borrowers.
The CFPB said that qualified mortgages also prohibit terms in excess of 30 years, interest-only payments and negative amortization.
The maximum DTI ratio on a qualitied mortgage is 43 percent.
“Before the crisis, many consumers took on mortgages that raised their debt levels so high that it was nearly impossible for them to repay the mortgage considering all their financial obligations,” the CFPB said.
However, during a temporary transitional period, loans with DTI ratios higher than 43 percent will count as qualified mortgages. The temporary QM category allows more flexible underwriting requirements as long as the QM product feature requirements are adhered to and the loan qualifies for purchase, insurance or guarantee by either Fannie Mae, Freddie Mac, the Federal Housing Administration, the Department of Veteran Affairs or the Department of Agriculture or Rural Housing Service.
The temporary category will be phased out in no less than seven years.
Balloon payments aren’t allowed on a qualified loan.
An exception to the balloon-payment prohibition was made, however, for fixed-rate loans made by a small creditor with less than $2 billion in assets operating in rural or underserved area with fewer than 500 first mortgages originated annually. The minimum balloon term is five years, while the loan must be held in the bank’s portfolio for at least three years.
The community bank provision is designed to ensure credit availability in rural areas where only balloon-payment products are offered.
Two separate qualified mortgage scenarios were outlined by the infant agency.
The first involves higher-priced loans generally made to weak borrowers. Lenders are presumed to have determined that borrowers had the ability to repay the loans — though consumers can challenge that presumption by proving they did not have sufficient income to pay the mortgage and other obligations.
In the second scenario, lower-priced prime mortgages made to less risky borrowers provide lenders with a safe harbor. Consumer can challenge the safe harbor status by proving that the loan didn’t meet the definition of qualified mortgage.
“We have addressed the legal consequences of a qualified mortgage by conferring the strongest legal protection on safer prime loans, while permitting borrowers to rebut the presumption of ability to repay for subprime loans,” Cordray stated. “We have limited the opportunities for unnecessary litigation, however, in three ways: by drawing bright-line criteria to define a qualified mortgage; by specifying that sustained payment over a reasonable period is strong evidence that the borrower had the ability to repay the loan when it was made; and by specifying the circumstances under which a borrower can rebut the presumption for subprime loans.”
MBA’s Still applauded the safe harbor provision, which she said “should allow lenders to offer sustainable mortgage credit to a great number of qualified borrowers without having to risk unreasonable and overly punitive litigation and penalties.”
Fitch Ratings said this week that the CFPB’s release of the QM definition is a milestone for the residential mortgage-backed securities market.
“Final clarity as to what constitutes a qualified mortgage and the likelihood of increased issuance will be key developments that will shape the coming year for U.S. RMBS,” the ratings agency said.
The CFPB additionally said that is it releasing proposed amendments to the ability-to-repay rule that would exempt certain nonprofit creditors that work with low- and moderate-income consumers; make exceptions for certain homeownership stabilization programs like the Making Home Affordable program; and provide QM status for certain portfolio loans made by small creditors like community banks and credit unions.
Cordray described how community financial institutions operate through a model has long served rural residents, like those from the small Ohio town is he from, in a way that traditional lenders can’t.
The proposed amendments invite public comment about how to calculate loan origination compensation under QM points and fees provision.
If adopted, the proposed amendments would also go into effect in January 2014.
“To help creditors with compliance, the CFPB will, among other things, be publishing plain-language translations of the regulation for lenders in booklet and video form, issuing implementation guides, and, in coordination with other agencies, releasing materials that help lenders understand supervisory expectations,” the announcement stated.
Another issue touched upon in Cordray’s presentation were appraisals. He cited a Michigan couple with credit scores in the 800s and equity in their property who were kept from refinancing because no comparable sales could be found in their neighborhood over the last twelve months.