New Ability-to-Pay Rule + Fair Lending = Rock and Hard Place?

This morning, the Consumer Financial Protection Bureau (CFPB) issued its long-awaited final “Rule to Protect Consumers from Irresponsible Mortgage Lending.” The new Ability-to-Pay rule also defines a segment of loans called “qualified mortgages” that are “safe” to originate.

As a result, Compliance Officers are asking themselves the question, “Is it possible to meet the requirements for QM (Qualified Mortgages) and later be cited for Fair Lending infractions?”

Based on the popular press headline coverage, this was the most watched regulatory move in recent history. The rule has been established in order to require lenders to ensure borrowers have the ability to repay their mortgage. The rule will take effect on January 10th, 2014.

Thursday morning’s front-page headlines announced:

• The Washington Post: “New Rules Make Mortgages Harder to Get”
• Wall Street Journal: “New Rules are Set for Home Lenders”
• USA Today: “New Mortgage Rule Aims to Protect Borrowers”

In every instance, the popular press is reporting on two primary themes: 1) the new federal rule will give consumers more protection against risk mortgages (provides more protection against “risky” mortgages), but 2) may make it harder for some borrowers to qualify. The CFPB estimates that about three-quarters of the mortgages issued in 2011 met the debt-ratio limit and the other standards of qualified mortgages.

The CFPB Summary of the Ability-to-Pay rule explained that qualified mortgages generally will be provided to people with debt-to-income ratios less than or equal to 43 percent. The Ability-to-Pay rule also implements a special Dodd-Frank Act provision that treats certain balloon-payment loans as qualified mortgages if they are originated and held in portfolio by small banks in predominantly rural or underserved areas.

ABILITY-TO-PAY RULE SHEET HIGHLIGHTS:

The basic idea is to ensure borrowers have the ability to repay a loan. Some of the highlights from the rule sheet include:

• Lenders have to determine the consumer’s ability to pay back both the principal and the interest over the long term – not just during an introductory period when the rate may be lower. 
• Lenders can no longer offer no-doc, low-doc loans, otherwise known as “Alt-A” loans, where some lenders made quick sales by not requiring documentation, then off loaded these risky mortgages by selling them to investors.
• Financial information has to be supplied and verified. 
• Therefore, at a minimum, a lender must consider eight underwriting standards:
1. Current income or assets;
2. Current employment status;
3. Credit history;
4. The monthly payment for the mortgage;
5. The monthly payment on any other loans associated with the property;
6. The monthly payment for other mortgage related obligations (such as property taxes);
7. Other debt obligations; and
8. The monthly debt-to-income ratio or residual income the borrower would be taking on with the mortgage. As you know, debt-to-income is a consumer’s total monthly debt divided by their total gross income.
• A borrower has to have sufficient assets or income to pay back the mortgage. 
• Therefore, lenders must make the determination the borrower can repay the loan by looking at the borrower’s income and any assets they may have on hand.
• Teaser rates can no longer mask the true cost of a mortgage. 
• Therefore, lenders can’t base their evaluation of a consumer’s ability to repay the loan on teaser rates. Lenders will have to determine the consumer’s ability to repay both the principal and the interest over the long-term.

QUALIFIED MORTGAGES DEFINED:

Some say that this is the most important part of the new Ability-to-Pay rule. The new category of “qualified mortgages” define which loans are guaranteed to comply with the ability-to-pay rule. Lenders will be presumed to have complied with the Ability-to-Pay rule if they issue Qualified Mortgages. Qualified Mortgages must meet certain requirements which prohibit or limit the risky features that harmed consumers in the recent mortgage crisis.

Features of Qualified Mortgages include:

• Cap on how income can go toward debt: Qualified Mortgages generally will be provided to people who have debt to income ratios less than or equal to 43 percent. For a temporary, transitional period, loans that do not have a 43 percent debt-to-income ratio but meet government affordability or other standards (i.e. Fannie Mae, Freddie Mac) will be considered Qualified Mortgages.
• No excess upfront points and fees: A Qualified Mortgage limits points and fees including those used to compensate loan originators, such as loan officers and brokers. In general, fees and points cannot exceed 3 percent of the total loan amount.
• No toxic loan features: Qualified Mortgages can’t have the loan features that were associated with risky mortgages (no interest only loans, no loans where the principal amount increases, no loans where the term is longer than 30 years).
• No loans with a balloon payment except those made by smaller creditors in rural or underserved areas: The law generally prohibits loans with balloon payments from being Qualified Mortgages. Balloon-payment loans require a larger-than-usual payment at the end of the loan term. A small creditor operating in rural or underserved areas is permitted to originate such loans as Qualified Mortgages under certain defined circumstances. 

Two Types of Qualified Mortgages (QM): 

• Qualified Mortgages with rebuttable presumption: These are higher-priced loans typically for consumers with insufficient or weak credit history. If the loan goes south, the consumer can rebut the presumption that the creditor properly took into account their ability to repay the loan. They would have to prove the creditor did not consider their living expenses after their mortgage and other debts. This does not affect the rights of a consumer to challenge a lender for violating any other federal consumer protection laws. 
• Qualified Mortgages with safe harbor: These are lower-priced loans that are typically made to borrowers who pose fewer risks. If the loan goes south, the lender will be considered to have legally satisfied the ability-to-repay requirements. But consumers can still legally challenge their lender under this rule if they believe that the loan does not meet the definition of a Qualified Mortgage. This does not affect the rights of a consumer to challenge a lender for violating any other federal consumer protection laws. 

Despite the headlines from the popular press, there is some good news.

The CFPB designed the rules to allow more loans to attain the “qualified mortgage” status, making it less restrictive than many lenders had initially expected. For example, there are no down payment and credit score requirements.

CFPB has acknowledged the “restriction of credit” concern and is evidenced by the following: "Our goal here is not only to stop reckless lending, but to enable consumers to access affordable credit," said CFPB Director Richard Cordray in prepared remarks to be delivered Thursday in Baltimore. "We can draw up the greatest consumer protections ever devised, but if consumers cannot get credit, then there is nothing to protect."

CFPB REQUEST FOR COMMENT:

In addition to the new Ability-to-Repay rule, the CFPB also released proposed amendments to the new rule. The CFPB is inviting comment on proposed amendments to its Ability-to-Repay rule that include:

• Exemptions for nonprofit creditors that work to help low- to moderate-income consumers obtain affordable housing; 
• Exemptions for housing finance agencies and lenders participating in housing finance agency programs intended to foster community development; 
• Exemptions for homeownership stabilization programs that work to prevent foreclosures, such as programs operating in conjunction with the Making Home Affordable program; 
• A provision to give Qualified Mortgage status to small creditors, such as community banks and credit unions that make and hold loans in their own portfolios. 
• As part of this proposal, the CFPB is also seeking comment on how best to calculate the loan origination compensation that will be part of the limitation on points and fees for Qualified Mortgages.

TRUPOINT PARTNERS BOTTOM LINE:

A large majority of community banks were never involved with the lending products that created the mortgage crisis.  With this said, a Qualified Mortgage must meet these eight points:

1. DOCMENTATION REQUIRED: Lender documents and verifies income and financial resources.
2. DEFINED DEBT-TO-INCOME THRESHOLD: 43% DTI regulations meet.  Teaser rates cannot be used to calculate DTI.
3. POINTS AND FEES: Total points are not more than 3% of loan.
4. NO GROWING BALANCE: Principal doesn’t increase.
5. NO INTEREST ONLY: No deferment of principal.
6. NO BALLOON: No balloon payment (note safe harbor for small creditor exception if originated and held in portfolio).
7. AMORTIZATION: Loan is fully amortized.
8. TERM: Loan is not more than 30 years in length.

Any loan that does not comply with these rules increases risk to the lender.

The rule is not scheduled to take effect until January 10th, 2014. This will allow time for the industry to review the detailed rule and digest the new rule. The biggest question that remains is how the regulators look to manage these new standards in comparison to their Fair Lending regulatory compliance expectations. To be clear, the new rules and Qualified Mortgage do not eliminate any Fair Lending claims for the lender.  

The CFPB has promised to share materials “in plain language” to help lenders and consumers understand the rules.

This is the first of many new rules on mortgage lending from the CFPB.  The team at TRUPOINT Partners will continue to work hard to understand, interpret and provide guidance to our clients.  

A great way to discover how we can help you is through a complimentary risk review.

IMPORTANT LINKS: 

• CFPB Press Release on Rule to Protect Consumers from Irresponsible Mortgage Lending
• Ability-to-Repay Summary
• CFPB to Repay Fact Sheet