On January 10, the Consumer Financial Protection Bureau (CFPB) issued a final rule, as mandated by provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act (DFA), which requires mortgage lenders to consider a consumer’s ability to repay residential mortgages before extending credit (the Rule). The Rule also establishes the standards for a loan to be considered a “Qualified Mortgage.” The Rule will take effect on January 10, 2014, giving lenders a year to establish compliance procedures.
Ability to Repay. In making ability-to-repay determinations, the Rule requires that lenders meet certain minimum requirements including consideration of various underwriting factors as well as the use of reasonably reliable third-party records to verify the information used to evaluate such factors. The Rule does not require lenders to use any particular underwriting model, but lenders must at a minimum consider underwriting factors such as a consumer’s current or reasonably expected income or assets, current employment status, credit history, and monthly payment of the transaction, among other factors. The Rule also has provisions to encourage lenders to refinance “non-standard mortgages” into “standard mortgages.”
Qualified Mortgages. Generally, if a lender originates a Qualified Mortgage as defined by the Rule, it is presumed that the lender has “made a good faith and reasonable determination of the consumer’s ability to repay” and is therefore compliant with the Rule. Below is a summary of the definition of a Qualified Mortgage with some additional caveats for higher-priced loans and certain loans in rural areas.
Qualified Mortgage – A Qualified Mortgage must have the following attributes: (1) no negative amortization, (2) no interest-only payments, (3) no balloon payments, (4) terms cannot exceed 30 years, (5) cannot be a “No-doc” loan, (6) points and fees cannot exceed 3 percent of the total loan amount, and (7) the consumer’s debt-to-income ratio must be less than or equal to 43 percent.
Safe Harbor for ‘Prime’ Loans or Rebuttable Presumption for ‘Higher Priced’ Loans – One of the questions that the mortgage industry has been grappling with is whether originating a Qualified Mortgage would provide lenders with either a safe harbor or a less-protective rebuttable presumption of compliance with the Rule. The Rule in fact provides both. As lenders had hoped, the Rule provides lenders with a safe harbor for origination of a Qualified Mortgage. However, origination of a “higher priced” mortgage (as defined by existing regulations adopted by the Federal Reserve Board in 2008) that otherwise has the attributes of a Qualified Mortgage creates a rebuttable presumption of compliance with the Rule. Consumers may rebut this presumption by showing that, at the time the loan was originated, the consumer’s income and debt obligations left insufficient residual income or assets to meet living expenses.
Non-Qualified Mortgage that Meets GSE Underwriting Requirements – On a temporary basis, a mortgage loan made to a consumer whose debt-to-income ratio is greater than 43 percent will be deemed a Qualified Mortgage so long as the mortgage satisfies the other safe harbor requirements of the Rule (as described above) provided it is eligible to be purchased, guaranteed, or insured by (1) the Government Sponsored Enterprises (i.e., Fannie Mae and Freddie Mac) or (2) other federal agencies (i.e., the U.S. Department of Housing and Urban Development, etc.). Unless the federal agencies issue their own qualified mortgage rules, this temporary provision will remain in effect for seven years.
Balloon Payment Qualified Mortgage in Rural Areas – Certain balloon-payment loans will be Qualified Mortgages if they are originated and held in portfolio by small creditors operating predominately in rural or underserved areas. The CFPB will issue a list of such areas.
Pepper Points: We will provide more extensive analysis of the Rule as we perform an in-depth review of its provisions. The CFPB’s issuance of the Rule gives lenders some much-needed clarity with regard to mortgage lending compliance under the DFA. However, it is sure to limit the availability of credit. Specifically, the Rule will create further disincentives for lenders to make loans that fall outside the Qualified Mortgage definition, so that subprime borrowers will have more difficulty obtaining mortgage loans going forward.
The Rule is only one piece of the puzzle, as the CFPB is expected to release at least six additional rules in the near future that will affect all aspects of mortgage banking. Pepper Hamilton has established a working group of experienced financial services attorneys who will closely follow the implementation of the new rules and provide insightful analysis to help our clients navigate the changing landscape of mortgage banking. We will continue to review the Rule and will be providing a more-detailed analysis of its provisions once we have completed our review.