CFPB Issues Small Entity Compliance Guide

On April 10, 2013, the CFPB released its Small Entity Compliance Guide to the Ability to Repay and Qualified Mortgage rules. The Guide leaves much to be desired when it comes to comprehensive guidance regarding compliance with these two rules; however, it does contain a number of “implementation tips” that are useful to know. The following are some of the most helpful tips.

The Ability to Repay

• Modification v. Refinancing. The Guidance points out that the Truth in Lending Act does not apply to a modification of an existing loan; it only applies to refinancings. A workout loan might be a modification and might not be subject to Truth in Lending. If Truth in Lending does not apply, then neither does the ATR. But remember, the substitution of a new obligation in place of an old obligation will always be subject to Truth in Lending requirements, and an upward adjustment in interest rate will take the transaction out of the status of a modification. At first blush, this approach seems to offer a solution to the problem of existing balloon loans that will mature after January, 2014. However, these loans were originated as balloon loans to deal with interest-rate risks, and interest rates will almost surely be on the increase in the not too distant future. Whether this tip proves very useful or not will remain to be seen.
• Policies and Procedures. It goes without saying that every bank will need to evaluate and revise their loan underwriting policies and procedures to document that each of the eight underwriting criteria required by the ATR are taken into account. Remember that this requirement will apply regardless of whether your bank chooses to originate Qualified Mortgages or not. This is a logical starting point for your entire ATR/QM compliance process.
• Verification of Income and Employment. The Guidance takes the reasonable position that you only need to verify and document sufficient income and assets to determine an applicant’s ability to repay. If there are multiple sources of income, but one source by itself is sufficient, that source alone is all you would need to verify. You can verify employment in a conversation with the applicant’s employer, but remember that you must document your conversation. The CFPB takes the position that you don’t have to retain a paper documentation trail, but you must be able to reproduce your records accurately.
• Reasonably Reliable Third-Party Records. The Guidance provides a helpful list of reliable records. None of these will be a surprise, but it could serve as a list of records to include in your underwriting policy. It goes on to offer a tip: when a consumer lists a debt on his or her application that does not appear on the credit report you pull, you must include the debt in your debt-to-income calculation, but you do not have to verify that debt.
• Verifying Income, Assets, Employment and Credit History. You only need to verify what is relied upon to determine ATR. However, all eight criteria must be addressed. If two consumers apply, you do not have to verify both incomes, unless both incomes are needed to qualify for the loan. Seasonal income, bonuses or future income can be relied upon if verified by reasonably reliable third-party records. Self-employment income should be supported by a third-party accountant’s verification of that income.
• Credit History. If a credit report shows a dispute or a fraud alert, you can disregard the disputed information.
• Debt-To-Income Calculation. You should include in a consumer’s total debt figure all ongoing, required monthly, quarterly or annual debt payments of the consumer. Do not include any debts that will be paid off as a part of your loan closing. If the debt has a variable interest rate feature, use the greater of the fully-indexed rate or any introductory rate. Remember that the debt-to-income calculation must be based on substantially equal monthly payments that would fully amortize the debt. If a balloon payment is involved, use the maximum payment scheduled in the first five years for a non-higher-priced loan, or the balloon payment itself for a higher-priced loan. Payments are “substantially equal” if no two payments vary by more than 1%. If a HELOC is involved as a simultaneous loan, you would calculate that monthly payment using the amount to be drawn against the line at the time of closing.
• Debt Obligations. You do not have to consider or verify the debt obligations of someone who is merely a guarantor or surety for the loan.

The Qualified Mortgage

• Safe Harbor v. Rebuttable Presumption of Compliance. For a higher-priced Qualified Mortgage, there would only be a rebuttable presumption of compliance. If the consumer could show that, based on the information you had when the loan was made, the consumer did not have enough residual income left to meet living expenses after paying their mortgage and other debts, the presumption of compliance would be rebutted. If the Qualified Mortgage is not higher-priced, the consumer has no recourse and the bank has its safe harbor. The rebuttable presumption provides more legal protection than simply complying with the general Ability To Repay requirements, but less protection and certainty than the safe harbor.
• Use of Credit Report for Qualified Mortgage. Although consideration and verification of a consumer’s credit history are not specifically a part of the definition of a Qualified Mortgage, you do have to consider the consumer’s debt obligations using reliable third-party records, which may include a credit report or nontraditional credit references.
• Calculating Points and Fees. The calculations here are the same as they would be for a HOEPA loan. You must include all amounts known at or before loan closing, even if they are paid at or after closing by rolling them into the loan amount. Six categories of charges must be added together:

1. Finance Charge. All items of finance charge will be included except for:
   1. Interest;
   2. Mortgage insurance premiums (FHA, VA, etc.);
   3. Private mortgage insurance premiums (PMI) (Note: you must include any amount of PMI that exceeds the up-front MIP for FHA loans);
   4. Bona fide third-party charges not retained by the creditor, loan originator or any affiliate (e.g., attorney’s closing fees, etc.);
   5. Bona fide discount points (up to 2 points for loans that do not exceed the APOR by more than 1%; up to 1 point so long as the rate before the discount does not exceed the APOR by more than 2%.) (Note: To be “bona fide” the discount must reduce the rate by an amount that reflects industry norm for secondary mortgage transactions.)
2. MLO Compensation. You must include amounts paid directly or indirectly by either the consumer or the creditor to a loan originator (e.g., a broker or retail loan officer). Include the following:
   1. Compensation paid directly by the consumer;
   2. Compensation paid by the bank to a broker;
   3. Compensation paid by the bank to its loan officer for originating the loan.
3. Real Estate-Related Fees. Provided the charges are reasonable and neither the bank nor an affiliate retains any portion of the charges, you can exclude the following from the points and fees calculation:
   1. Fees for title work, title insurance, survey, etc.;
   2. Fees for document preparation;
   3. Notary and credit-report fees;
   4. Appraisal or inspection fees (including pest and flood- hazard determination);
   5. Amounts paid into escrow that are not included in the finance charge.
4. Premiums for Credit Insurance; Credit Property Insurance; Other Insurance Where the Bank is the Beneficiary; and Debt Cancellation Products.
5. Maximum Prepayment Penalties; and
6. Prepayment Penalty Paid in a Refinance Transaction.

• Prepayment Penalties. Prepayment penalties are not totally prohibited, but can only be charged for fixed-rate or step-rate Qualified Mortgages that are not higher-priced. Note that bona fide third-party charges that were waived at closing (but were expected to be recovered through the interest rate over time) can be recouped if the consumer prepays during the first three years, and not be counted as a prepayment penalty. Prepayment penalties can only be charged during the first three years of the loan and are limited to 2% during the first two years and 1% the third year. If you wish to charge a prepayment penalty, you must offer the consumer an alternative loan that he will qualify for which does not feature a prepayment penalty. That alternative loan must be a fixed-rate loan with the same term as the prepayment penalty loan. It cannot have negative amortization, interest only payments or balloon payments.

The foregoing is by no means a comprehensive guide to complying with the ATR or the origination of Qualified Mortgages, but it does provide a number of helpful pointers and will prove useful when it comes time to draft policies and procedures for ATM and QM compliance. We will address these points in greater detail at the May Quarterly Meeting.