The Consumer Financial Protection Bureau (CFPB or Bureau) issued a proposed rule on August 18 to create a new category of seasoned qualified mortgages (Seasoned QMs) that, if finalized as written, would carry significant implications for the residential mortgage marketplace.
This announcement was not unexpected, as the CFPB announced at the end of June that it was considering issuing such a proposed rule later this year. Unless the Bureau changes its approach in response to industry comments, the implications of the proposed rule, if enacted, may lie well in the future: as proposed, the first loans that meet the definition of Seasoned QMs will not exist until at least 2024.
The Dodd-Frank Act amended the Truth in Lending Act (TILA) to establish ability-to-repay (ATR) requirements for most residential mortgage loans. TILA identifies factors a creditor must consider in making a reasonable and good-faith assessment of a consumer’s ATR. TILA also defines a category of loans called qualified mortgages (QMs), which are presumed to comply with the ATR requirements.
In January 2013, the Bureau completed an ATR/QM rule that established a general QM standard (the General QM category) for loans where the consumer’s debt-to-income (DTI) ratio is 43% or less and the loan meets the other statutory QM requirements. With certain exceptions, Regulation Z (TILA’s implementing regulation) requires creditors to make a reasonable, good faith determination of a consumer’s ability to repay any residential mortgage loan, and loans that meet Regulation Z’s requirements for QMs obtain certain protections from liability. Regulation Z contains several categories of QMs, including the General QM category and a temporary category (Temporary GSE QM loans) of loans that are eligible for purchase or guarantee by government-sponsored enterprises (GSEs) while they are operating under the conservatorship or receivership of the Federal Housing Finance Agency (FHFA).
As drafted, only certain loans are eligible to become Seasoned QMs. Specifically, a covered transaction would have to meet the following criteria in order for a loan to be eligible to become a Seasoned QM:
- the loan is originated based on an application received after the effective date of the rule, likely mid-2021 at the earliest;
- the loan is secured by a first lien;
- the loan has a fixed rate, with fully amortizing payments and no balloon payment;
- the loan term does not exceed 30 years; and
- the total points and fees do not exceed specified limits.
Once originated, covered transactions would then generally have to be held in the originating lender’s portfolio for a 36-month seasoning period and meet certain underwriting requirements. The proposed rule generally defines this 36-month seasoning period as beginning on the date on which the first periodic payment is due after consummation. For a loan to be eligible to become a Seasoned QM, the proposed rule would also require that the creditor consider and verify the consumer’s debt-to-income ratio (DTI) or residual income at origination. Similar in several respects to the requirements established for certain portfolio loans originated by certain small creditors (Small Creditor QMs), the proposed rule would not specify a DTI limit, nor would it require the creditor to use appendix Q to Regulation Z in calculating and verifying debt and income. However, unlike Small Creditor QMs, Seasoned QMs would not be limited to small creditors.
Seasoned QMs would only be available for covered transactions that have no more than two 30-day delinquencies and no delinquencies of 60 or more days as of the end of the seasoning period. Funds taken from escrow in connection with the covered transaction and funds paid on behalf of the consumer by the creditor, servicer, or assignee of the covered transaction (or any other person acting on the consumer’s behalf) would not be considered in assessing whether a periodic payment has been made or is delinquent for purposes of the proposed rule. Creditors could, however, generally accept deficient payments within a payment tolerance of $50 on up to three occasions during the seasoning period without triggering a delinquency for purposes of the proposal.
Also, should there be a disaster or pandemic-related national emergency and as long as certain conditions are met, the proposed rule would not disqualify a loan from becoming a Seasoned QM as a result of the failure of the related consumer to make full contractual payments if, as a result of such disaster or emergency, the consumer receives a temporary payment accommodation. However, time spent in such a temporary accommodation would not count towards the 36-month seasoning period, and the seasoning period could only resume after the temporary accommodation if any delinquency is cured either pursuant to the loan’s original terms or through a qualifying change as defined in the proposed rule.
Under the proposed rule, a covered transaction would receive a safe harbor from ATR liability at the end of the 36-month seasoning period as a Seasoned QM if it satisfies such product restrictions, points-and-fees limits, and underwriting requirements, and if it meets such performance and portfolio requirements during the seasoning period.
According to the Bureau, the new Seasoned QM definition “could complement existing QM definitions and help ensure access to responsible, affordable mortgage credit upon the expiration of one of the existing QM definitions.” The Bureau states that it issued this proposed rule because “it seeks to encourage safe and responsible innovation in the mortgage origination market, including for certain loans that are not QMs or are only rebuttable presumption QMs under the existing QM categories.” The Bureau preliminarily concludes that it is appropriate to presume compliance with the ability-to-repay (ATR) requirements when such loans season in the manner set forth in the proposed rule. In large part, the proposed rule reflects the Bureau’s understanding that many borrowers who have the ability to repay, such as those with nontraditional credit profiles or income sources, may fall outside existing QM definitions.
This announcement follows two proposed rules from earlier this year regarding qualified mortgages. In the first proposed rule (the General QM Proposal), the Bureau proposed to amend the General QM category in Regulation Z to replace the 43% DTI limit with a price-based approach. In the second proposed rule (the Extension Proposal), the Bureau proposed to amend Regulation Z to extend the so-called “GSE Patch” in respect of Temporary GSE QM loans that is set to expire upon the effective date of a final rule regarding the proposed amendments to the General QM category in Regulation Z (as referenced above). The GSE Patch refers to a temporary category of QM loans that: (i) comply with the same loan-feature restrictions and points-and-fees limits as General QM category loans; and (ii) are eligible to be purchased or guaranteed by the GSEs while under the conservatorship of the FHFA. Unlike its application to the General QM category, Regulation Z does not prescribe a DTI limit for GSE Patch QM loans. We previously reported on these earlier proposals.
- Whether the Bureau ultimately succeeds in adopting this approach in an effective final rule likely depends on a number of factors: the extent of pushback from consumer groups; the timing of the issuance of the final rule relative to the November election; and how strong a record the Bureau can build in the rulemaking process to defend its decision to significantly expand the QM definitions. The last of these factors is of paramount importance because the statutory default for a creditor’s determination of a borrower’s ability to repay provides that such determination is made at the time the loan is consummated. While the Bureau is permitted to revise the QM safe harbor criteria, it opens itself to challenge under the Administrative Procedures Act (APA) if it has not developed a record showing that a mortgage that was originated as a non-QM or rebuttable presumption QM should nevertheless still be eligible to season into a QM safe harbor loan.
- The impact of the Seasoned QM proposal on the existing residential mortgage market, if finalized as proposed, would appear to be muted, at least in the short term. For example, the proposed Seasoned QM category would not apply to existing and older loans which have been performing for 36 months, but were originated prior to the effective date of the new rule. Rather, the Seasoned QM category, if finalized as proposed, would apply to covered transactions for which creditors receive an application on or after the effective date (which would be sometime in 2021, at the earliest). Accordingly, the earliest that any loans would receive the benefits of Seasoned QM status would be at least three years after the effective date. In addition, loan performance which is a result of a modification to the original terms of a loan would also disqualify that loan from the proposed Seasoned QM category, unless any disruptions in performance were as a result of a disaster, pandemic, or other qualifying emergency and any temporary relief that has been granted as a result of such a disaster or emergency has been resolved—or the loan is formally refinanced as a “new” extension of credit. For example, the proposed rule would not create a path to Seasoned QM status for a loan such as a re-performing loan (RPL) that is otherwise presently 36 months current, but following a modification (as opposed to being current for 36 months following origination). Allowing an alternative pathway to a QM safe harbor – as the Seasoned QM purportedly is designed to do – may encourage creditors to lend to consumers with less traditional credit profiles and income sources at an affordable price based on an individualized determination of a consumer’s ability to repay (and potentially employ innovative methods of assessing financial information in doing so). For example, new technology allows creditors to assess financial information that may not be readily apparent through a traditional credit report, such as a consumer’s ability to consistently make on-time rent payments. Additionally, technology platforms have led to rapid growth in the “gig economy,” through which workers earn income by providing services such as ride-sharing and home delivery and through the ability to earn income on assets such as a home. Some workers participate in the gig economy for their sole source of income, while others may do so to supplement their income from more traditional employment.
- Providing creditors with the proposed alternative pathway to a QM safe harbor for these types of loans may incentivize creditors to originate certain loans that may not otherwise have been made in the absence of potentially greater ATR compliance certainty. A final rule allowing performing loans to season into QM status could clarify a creditor’s litigation risk and this could potentially help to bring certainty to secondary market participants that might otherwise be unable or unwilling to accept the litigation risk associated with assignee liability under both rebuttable presumption QM and non-QM loans.
- The Bureau proposes that a final rule relating to this proposed rule would take effect on the same date as a final rule amending the General QM category. In the General QM Proposal, the Bureau proposed that the effective date of a final rule relating to the General QM Proposal would be six months after publication in the Federal Register.
- Industry participants should closely follow the Bureau’s rulemaking processes for all of these proposed QM amendments and any follow-on litigation challenging the rulemakings. The final rules that become effective may be very different from the proposed rules.