On January 10, 2013, the CFPB issued its concurrent rule setting forth the Ability-to-Pay provisions contained in the Dodd-Frank Act and the Qualified Mortgage Rule which provides certain possible protections for lenders from the possible liabilities they might encounter if they fail to satisfy the Ability-to-Pay requirements.
Many observers feel that the potential for significant liability under the Ability-to-Pay Rule will cause lenders to only originate Qualified Mortgages, and that the requirements and limitations of a Qualified Mortgage will significantly reshape residential mortgage lending for all banks.
As you know, the Federal Reserve Board adopted a Rule in 2008 which imposed an ability to repay requirement on all loans that were classified as “higher-priced mortgage loans.” The Dodd-Frank Act significantly expanded the universe of loans now covered by this Rule. Now, the Ability-to-Pay Rule applies to any consumer credit transaction secured by a dwelling, except for HELOC’s, time-share plans, reverse mortgages and temporary or bridge loans.
The Final Rule provides that a creditor is prohibited from making a covered mortgage loan unless the creditor makes a reasonable and good faith determination, based on verified and documented information, that the consumer will have a reasonable ability to repay the loan, including any mortgage-related obligations such as taxes and insurance.
Although the Final Rule states that no attempt is being made to provide comprehensive underwriting standards to which creditors must adhere, it does provide that at a minimum the creditor must consider and verify each of the following:
- Current or reasonably expected income or assets;
- Current employment status;
- The monthly payments on the current transaction;
- The monthly payment on any simultaneous loan;
- The monthly payment for mortgage-related obligations;
- Current debt obligations;
- The monthly debt-to-income ratio or residual income; and
- Credit history.
It bears repeating that these items related to an applicant’s ability-to-pay need to be both verified, using reliable third-party records, and documented. The CFPB’s Final Rule provides special rules for verification of income and assets.
The Final Rule provides a “safe harbor” for loans that satisfy the definition of a Qualified Mortgage and that are not “higher-priced” mortgages (i.e., the APR does not exceed the Average Prime Offer Rate (APOR) plus 1.5% for first-lien loans or 3.5% for subordinate-lien).
Qualified mortgage loans that are higher-priced receive only a presumption of compliance, meaning the borrower can challenge whether or not the bank actually made a proper determination that the borrower did, in fact, have the ability to repay the loan that was obtained.
It helps to think of a Qualified Mortgage definition as having three parts: (1) the product features and points and fees charged which determine if the loan is a higher-priced loan or not; (2) the eight (8) underwriting requirements listed above; and (3) a determination of whether the consumer has a “back-end” debt-to-income ratio that is less than or equal to 43%. (Appendix Q of Regulation Z will provide methods for calculating debt-to-income.)
Then, there are two other possible ways for certain creditors to originate Qualified Mortgage’s. The first is to originate mortgage loans that meet the statutory limits on product features, points, fees and certain other requirements to be eligible for purchase, guarantee or insurance by government-sponsored agencies (GSE’s) such as Fannie Mae or Freddie Mac.
The second possibility is for a bank fall into the specially created category of small banks that operate predominantly in rural or underserved areas. For this unique (and very limited) group of banks, it will be possible to originate a Qualified Mortgage that satisfies all of the Qualified Mortgage requirements, but still can feature a “balloon payment.” (remember: the Dodd-Frank Act prohibits a balloon-payment mortgage loan from being a Qualified Mortgage, with this one limited exception.)
For many years, community banks, and many others, have used balloon payment loans as a method for keeping interest rate risks under control without the complexity of originating adjustable rate mortgage loans. If your bank does not qualify for this limited exception (explained more fully below), it will have to significantly adjust its dwelling-secured mortgage lending practices if it wants to originate Qualified Mortgages and receive either safe-harbor treatment or the benefit of at least a presumption of compliance with the Ability-to-Pay Rule. One of your first steps should be to ask yourself whether your bank will meet the following requirements.
To qualify for this limited exception a creditor must:
- Have assets of no more than $2 billion;
- Operate predominantly in “rural” or “underserved” areas;
- Have total annual residential mortgage loan originations that do not exceed 500 in number;
- Make at least 50% of its first-lien loans (included within the 500 loan limit) in “rural” or “underserved” Counties;
- Retain these balloon-payment loans in the bank’s loan portfolio.
The Final Rule tells us that a county is considered to be “rural” if it is not a Metropolitan Statistical Area (MSA) or a “Micropolitan Statistical Area” (one that is located adjacent to an MSA.) Furthermore, a County is considered “underserved” if no more than two creditors extend covered loans 5 or more times in that County during a calendar year. The CFPB will publish a listing of the counties within states that meet these requirements.
The first thing you should realize is that this is an “either/or” requirement. The counties in question must be either “rural” or “underserved” (of course both would be even better). We don’t know for certain, but this seems to be an exception with little or no application. How many banks operate predominantly in rural or underserved areas? How many originate fewer than 500 covered transactions (i.e., both first-lien and subordinate-lien loans)? And how many banks will have more than 50% of their first-lien covered loans secured by properties located in “rural” or “underserved” counties? Even if you think your bank might qualify, how close are you today to exceeding one or more of those limits? What will be the cost in time and expense required to monitor compliance with these limits? The CFPB explains that it recognizes the unique nature of smaller community banks, but one has to wonder if it really thought this one through. Banks in other parts of the country where counties are vast and populations are sparse, may see some relief, but banks in almost all other regions may see little relief when it comes to originating balloon loans as Qualified Mortgages.
But do give the CFPB some modicum of credit for at least trying to do some things to help community banks. Along with the Final Rule (discussed above) the CFPB has attempted to give some additional relief to small creditors. For instance, the Final Rule exempts banks with less than $2 billion in assets that operate in rural or underserved areas and make 500 or fewer first-lien mortgage loans per year, from the escrow account requirement that currently applies to higher-priced mortgage loans. (But remember that this exemption is so limited that it may not provide any real relief.)
The CFPB has also proposed a change to its Qualified Mortgage Rule that, if adopted, would raise the interest rate threshold for higher-priced, first-lien loans from 1.5% to 3.5% above the APOR. That change, again if adopted, would have the effect of extending the Qualified Mortgage safe harbor to certain higher-priced first-lien Qualified Mortgages made and held in portfolio by certain small creditors. Remember, however, that both of these changes are subject to the small creditor, rural or underserved area and number of loan restrictions that will make these attempts to help community banks possibly of little or no effect.
Finally, the CFPB included a proposal to add a fourth category of Qualified Mortgage which would include loans originated and held in portfolio by certain small creditors. This proposal would be similar in some ways to the provisions allowing small creditors to make balloon loans in rural or underserved areas. This additional proposed category of Qualified Mortgage, however, would differ in three ways: (1) the small creditor would not be required to operate in a rural or underserved area; (2) the portfolio loans could not feature a balloon-payment; and (3) while the creditor would still have to consider the consumer’s debt-to-income ratio or residual income, the creditor would not be limited by the calculations in Appendix Q of Regulation Z, and the consumer’s debt-to-income ratio could exceed 43% if justified in the creditor’s considered opinion.
Since comments are solicited, small community banks would be wise to let their thoughts be known. The CFPB is right — safe harbor protections are needed. The agency has correctly determined that exemptions from certain regulatory requirements are needed; however, they have completely misjudged whether these proposed measures will apply to many, or any, community banks because of the very limited number of banks that can meet these requirements. The proposal to eliminate the requirements related to rural and underserved counties should be adopted. Balloon-payment loans should be permitted for all banks meeting the asset size and number of transactions tests. If you wish to comment, those comments should be prepared and submitted promptly.
At our February Quarterly Meeting, we will have an extended discussion of both the Ability-to-Pay and Qualified Mortgage Rules, as well as their anticipated impact on a bank’s dwelling-secured loans.