The Consumer Financial Protection Bureau on June 22 issued two proposed rules with significant implications for the mortgage marketplace.
Of the two proposed rules from the Consumer Financial Protection Bureau (CFPB or Bureau), one quietly—but drastically—simplifies the definition of a “qualified mortgage,” and the other resolves lingering uncertainty regarding the impending expiration of the government-sponsored enterprises patch (GSE Patch), i.e., the “temporary qualified mortgage” exemption contained within the qualified mortgage/ability-to-repay rule.
Despite their technical-sounding features, these two rules together affect a huge portion of mortgage originations in the United States and have the potential to offer meaningful regulatory relief for mortgage originators and securitization participants—so long as the rules go into effect as written.
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.
The Bureau completed an ATR/QM rule that established a general QM standard (the General QM loan definition) for loans where the consumer’s debt-to-income (DTI) ratio is 43% or less and the loan meets the other statutory QM requirements.
The ATR/QM rule created the GSE Patch as a temporary QM definition that also provides QM status to certain mortgage loans eligible for purchase or guarantee by either of the GSEs (Temporary GSE QM loans). These Temporary GSE QM loans are eligible for QM status even if the DTI ratio exceeds 43%, and are not subject to the requirement to use Appendix Q to determine the consumer’s income, debt, or DTI ratio. The GSE Patch is scheduled to expire in January 2021 or when the GSEs (Fannie Mae and Freddie Mac) exit conservatorship, whichever comes first.
In 2019, the Bureau released an assessment of its ATR/QM rule and found that Temporary GSE QM loans represent a large and persistent share of mortgage originations. Since, as noted above, the GSE Patch is scheduled to expire soon, absent regulatory action the Bureau estimates that approximately 957,000 mortgage loans (based on closed-end first-lien mortgage loan originations in the United States in 2018 that had DTI ratios greater than 43%—loans that fall within the Temporary GSE QM loan definition but not the General QM loan definition) would be affected by the expiration of the GSE Patch. The Bureau also estimates that, after the GSE Patch expires, many of these loans would either not be made or would be made but at a higher price.
DEFINITION OF QUALIFIED MORTGAGE
In the first proposed rule, the Bureau proposes to amend the General QM definition in Regulation Z (TILA’s implementing regulation) to replace the 43% DTI limit with a price-based approach. The Bureau states that it is proposing a price-based approach because it “preliminarily concludes that a loan’s price, as measured by comparing a loan’s annual percentage rate to the average prime offer rate for a comparable transaction, is a strong indicator and more holistic and flexible measure of a consumer’s ability to repay than DTI alone.”
For eligibility for QM status under the General QM loan definition, the Bureau is proposing a price threshold for most loans as well as higher price thresholds for smaller loans. Under the proposed rule, a loan would meet the General QM loan definition only if the annual percentage rate (APR) exceeds the average prime offer rate (APOR) for a comparable transaction by less than two percentage points as of the date the interest rate is set, while higher thresholds would be provided for loans with smaller loan amounts and for subordinate lien transactions.
The proposed rule would retain the existing product feature and underwriting requirements and limits on points and fees, and require that lenders take into account a consumer’s income, debt, and DTI ratio or residual income, and verify the consumer’s income and debts (a safe harbor is proposed to creditors using verification standards the Bureau specifies). Additionally, the proposed rule would remove Appendix Q, but would include clarifications of the requirements to consider and verify a consumer’s income, assets, debt obligations, alimony, and child support, to help prevent compliance uncertainty that could otherwise result from the removal of Appendix Q.
The Bureau also is requesting comment on two alternative approaches: (1) retaining the DTI limit and increasing it to a specific threshold between 45% and 48%, or (2) using a hybrid approach involving both pricing and a DTI limit, such as applying a DTI limit to loans that are above specified rate spreads. If adopted in the final rule, the proposed departure from the complex DTI/Appendix Q approach in favor of the simplified pricing test for satisfaction of the General QM loan definition has the potential to make it much easier for both originators and securitization participants to gauge whether a particular mortgage loan in fact satisfies the rule.
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 abandon DTI. The last of these factors is of paramount importance because the statutory default standard for defining Qualified Mortgage under the Dodd-Frank Act depends on DTI. The Bureau is permitted to consider alternative standards but opens itself to challenge under the Administrative Procedures Act (APA) if it has not developed a record showing that its alternative metrics also measure a borrower’s “ability to repay.”
In the second proposed rule, the Bureau proposes to amend Regulation Z to extend the GSE Patch to expire upon the effective date of a final rule regarding the proposed amendments to the General QM loan definition in Regulation Z (as discussed above). The proposed rule does not amend the provision stating that the Temporary GSE QM loan category would expire if the GSEs were to exit conservatorship. The CFPB states that it is proposing to take this action “to ensure that responsible, affordable credit remains available to consumers who may be affected if the GSE Patch expires” before such proposed amendments take effect.
- The Bureau does not intend for the effective date of the proposed QM amendments to be prior to April 1, 2021 (therefore, the CFPB does not intend for the Temporary GSE QM loan definition to expire prior to April 1, 2021). This should help provide some certainty—at least for the next several months—to creditors and investors who have been concerned about the looming (and fast approaching) expiration of the GSE Patch. At this time, the Bureau proposes for the effective date of a final rule to be six months after publication in the Federal Register, and any such revised regulations would apply to covered transactions for which creditors receive an application on or after that effective date.
- The current approach to DTI ratios under the General QM loan definition may stifle innovation in underwriting because it focuses on a single metric, with strict verification rules, which may constrain new approaches to assessing repayment ability, including the use of technology as part of the underwriting process. Such innovations include certain new uses of cash flow data and analytics to underwrite mortgage applicants. This emerging technology has the potential to accurately assess consumers’ ability to repay using, for example, bank account data that can identify the source and frequency of recurring deposits and payments and identify remaining disposable income. Such innovation could potentially expand access to mortgage credit, particularly for applicants with non-traditional income and limited credit history.
- Industry participants should closely follow the Bureau’s rulemaking process for the General QM loan definition and any follow-on litigation challenging the rulemaking. The final rule that becomes effective may be very different from the proposed rule.
- In addition, the proposed removal of Appendix Q (if it becomes effective) may help alleviate investors’, and at least derivatively, creditors’ preference for Temporary GSE QM loans, given the perceived lack of clarity in Appendix Q and (what the Bureau even acknowledges to be) complexities associated with the current definitions of debt and income.