Everyone is awaiting the CFPB’s final word on the definition of a “Qualified Mortgage” (QM). Most observers feel that this single regulatory development may have more of an impact on community bank profitability, the availability of housing credit and the overall economic recovery than perhaps any other aspect of the Dodd-Frank Act. Whether that is true or not may be up for debate, but that the impact of the QM will be considerable is not in doubt. So, what exactly is a Qualified Mortgage? What is the CFPB trying to accomplish here?
To understand the reasoning behind the QM definition, you first need to understand the “Ability to Pay” Rule. This rule is an amendment to the Truth in Lending Act and applies to “residential mortgage loans.” That term includes virtually all consumer loans secured by a dwelling other than home equity lines of credit.
The expanded Ability to Pay Rule is similar to the Federal Reserve Rule for higher-priced mortgages adopted in 2008, but now applies to a much broader range of consumer loans. The Ability to Pay Rule requires a creditor to consider the following underwriting criteria for each individual borrower:
- Credit history,
- Current income,
- Expected income (reasonably anticipated),
- Current obligations,
- Debt-to-income ratio or residual income,
- Employment status, and
- Financial resources (other than the equity in the dwelling).
Income must be verified using W-2 tax forms, payroll receipts, etc. (some flexibility exists here for certain government guaranteed or insured loans).
Special rules apply for “nonstandard loans” such as variable-rate loans that defer repayment of principal or interest or loans that permit interest-only payments. For those loans, a creditor must use a repayment schedule that fully amortizes the loan.
These underwriting criteria can be onerous, and there is potential liability under the Truth in Lending Act for failure to comply with the Ability to Pay Rule. Failure to comply with the Ability to Pay Rule can also be asserted as a defense to foreclosure and a possible offset should a loan become delinquent.
To lessen the potential liability, the Dodd-Frank Act created a presumption of compliance to the extent that a creditor makes a QM.
A QM is defined as:
- A loan that features regular periodic payments which do not increase the principal balance or allow the borrower to defer the repayment of principal.
- A loan that does not result in a balloon payment.
- A loan for which the borrower’s income and financial resources are verified and documented.
- Either a fixed-rate loan where underwriting is based on a fully amortizing payment schedule, or an adjustable-rate loan where underwriting is based on the maximum rate possible in the first five years and a payment schedule that would fully amortize the loan over the loan term. Taxes, insurance and assessments must be included for both types of loans.
- The loan must comply with the guidelines established by the CFPB for debt-to-income.
- Total points and fees (same definition as for “high-cost” loans) cannot exceed 3% of the “total loan amount,” and
- The loan term may not exceed 30 years.
The CFPB has the authority to modify the definition of a QM to make allowances for loans of smaller amount. It also can provide for loans with balloon payments to qualify provided the loan otherwise meets all of the criteria except those applicable to the prohibition on deferred repayment of principal and the underwriting requirements for fixed- and variable-rate loans. Creditors will still have to verify that the borrower has the capacity to make all scheduled payments, other than the balloon payment, and the repayment schedule must be one that fully amortizes the loan over not more than 30 years. This exception for balloon payment loans will only be available to creditors that operate in primarily rural or underserved areas, that have annual originations that do not exceed a certain limit, that meet certain asset size criteria, and that retain the loan in portfolio. Other changes may be suggested to limit or avoid any undue impact on either the cost or availability of credit.
The CFPB is wrestling with another issue related to the QM: the question of whether making a QM should entitle a creditor to a “safe harbor” or merely a presumption of compliance. As you know, a safe harbor means you cannot be challenged on whether you have complied with the Ability to Pay Rule. A presumption of compliance would be rebuttable by a showing of contrary facts.
Creditors want a safe harbor; consumer advocates want only a presumption of compliance. The CFPB representatives have argued that a clear set of criteria, accompanied by a rebuttable presumption of compliance, might be the best approach since adhering to the clear criteria would mean that there is very little room to try to rebut the presumption of compliance.
The CFPB has also tossed out the idea of a two-part definition of QM. One set of criteria would be very conservative, or safe, and would be entitled to the safe harbor treatment. Another set of criteria would be more expansive and would only get a presumption of compliance. By using the two-tier definition, the CFPB would hope to overcome arguments that the QM definition is so restrictive that it would limit lending, impact earnings, impede the availability of credit, and perhaps increase the cost of mortgage loans that do get made.
We should know shortly the CFPB’s thoughts. The Board is under pressure to finalize its proposal by January 21, 2013.
In the past, banks have managed to get around many of the compliance headaches associated with restrictive loan products, such as HOEPA loans, by pricing those loans in a way that took all of their loans out from under the regulatory restrictions. You will not be able to do this with respect to QMs in all likelihood. Everyone should begin now to consider what the impact will be on loan products, bank income, Community Reinvestment Act compliance, Fair Lending, etc., if the Bank chooses to make QMs. Many areas, in addition to the Compliance Department, will be affected.