The Consumer Financial Protection Bureau (CFPB) issued its final ability to repay rule (Rule) on January 10, 2013. The Rule implements ability-to-repay provisions of the Dodd-Frank Act, which imposed strict underwriting standards upon lenders to ensure that prospective buyers have the ability to repay their mortgages. A failure to comply with these requirements will constitute a violation of the Truth In Lending Act (TILA) and subject the lender to significant penalties and possible rescission of the loan. However, loans that meet the definition of what has been termed a “qualified mortgage” (QM) are either exempt from these ability to pay requirements if the loans are viewed as prime, or will give rise to a rebuttable presumption of compliance if they are higher cost loans.

Qualified Mortgages and Treatment of Smaller Loans

In general, the Rule requires that monthly payments be calculated based on the highest payment that will apply in the first five years of the loan and that the consumer have a total debt-to-income ratio that is less than or equal to 43 percent. In order for a mortgage to be a qualified mortgage, the loan in essence must not contain certain undesirable terms or features such as negative amortization, interest-only payments, balloon payments, or terms exceeding 30 years. So-called “no-doc” loans where the creditor does not verify income or assets also cannot be qualified mortgages. Additionally, a loan generally cannot be a qualified mortgage if the points and fees paid by the consumer exceed three percent of the total loan amount for loans of $100,000 or more.

The Rule provides that points and fees retained by the affiliate of a creditor — such as the title insurance fees charged by an title agent or company that is affiliated with the lender — must be counted toward the 3% points and fees limit for QM, even though the same (or higher) fees of an unaffiliated company would not be counted toward this limit. This means that some lenders will be discouraged or prevented from using their affiliated title companies in many transactions because doing so may cause them to go over the 3% limit whereas if they used an independent title company, the fees would not count and they could avoid the risk of making a non-QM loan.

The CFPB raised the small loan exemption from $75,000 to $100,000. Under the Rule, the revised points and fees limits for smaller loans are a mix of percentage and flat dollar limits, as follows:

  • For a loan amount greater than or equal to $60,000 but less than $100,000, $3,000;
  • For a loan amount greater than or equal to $20,000 but less than $60,000, 5 percent of the total loan amount;
  • For a loan amount greater than or equal to $12,500 but less than $20,000, $1,000 of the total loan amount;
  • For a loan amount of less than $12,500, 8 percent of the total loan amount.

According to the CFPB, it intended its revised points and fees limits for loans under $100,000 to include more transactions in the exemption for smaller loans, which it believes will allow creditors making such loans a reasonable opportunity to recover their costs through points and fees and still originate qualified mortgages. The CFPB chose not to enlarge the exemption for smaller loans. It noted that in 2011, slightly under 21% of first-lien home mortgages were below $100,000 and another 22% were between $100,000 and $150,000. “Thus, increasing the threshold to $150,000 would more than double the number of loans entitled to an exception to the congressionally-established points and fees cap and would capture over 40 percent of the market,” which the CFPB believed “would be an overly expansive construction of the term ‘smaller loans’ for the purpose of the exception to the general rule capping points and fees for qualified mortgages at three percent.”

The effective date of the Rule is January 10, 2014, one year from the date of issuance. Under the Rule, all points and fees limits will be indexed for inflation. The CFPB declined to adopt a tolerance that would allow creditors to exceed the points and fees limits by small amounts.

Safe Harbor or Rebuttable Presumption?

With respect to the issue of what legal protection a QM will provide against a challenge based upon a violation of the ability to repay requirement — i.e., a safe harbor or a rebuttable presumption — the CFPB split the baby. The Rule distinguishes between two types of QMs based on the mortgage’s Annual Percentage Rate (APR) relative to the Average Prime Offer Rate (APOR). For loans that exceed APOR by a specified amount — loans denominated as “higher-priced mortgage loans” — the Rule provides a rebuttable presumption. In that instance, although the lender will be presumed to have determined that the borrower had an ability to repay the loan, the consumer can challenge that presumption by making certain showings. For all other loans, i.e., loans that are not “higher-priced,” the Rule will afford the creditor a safe harbor, which in essence provides the lender with an exemption from the ability to repay rules and accords far more protection than the rebuttable presumption.

Temporary Alternative QM Definition

Because the CFPB viewed implementation of its 43 percent debt-to-income ratio threshold as potentially harsh, it opted to provide a “temporary alternative” definition as a substitute for the general qualified mortgage definition. The temporary definition will apply to loans that meet the prohibitions on certain risky loan features (e.g., negative amortization and interest only features) and the limitations on points and fees and are eligible for purchase or guarantee by the Federal National Mortgage Association (Fannie Mae) or the Federal Home Loan Mortgage Corporation (Freddie Mac) or eligible to be insured or guaranteed by certain federal agencies such as the U.S. Department of Housing and Urban Development and the Department of Veterans Affairs.

Looking Forward

In the days to come, lender and brokers — particularly those with affiliated settlement service providers — will be examining the intricacies of the “points and fees” test and assessing what percentage of the loans they are making would run afoul of the 3% test under the Rule and at what loan amount. Legislative and business solutions (such as the possible use of no cost loans) will likely be fully explored during the coming year.

At the same time it issued the final QM Rule, the CFPB has released proposed amendments to the Rule that would, among other things, exempt certain nonprofit creditors that work with low- and moderate-income consumers, make exceptions for certain homeownership stabilization programs, and provide QM status for certain loans made and held in portfolio by small creditors. The proposed amendments also seek comment on how to calculate loan origination compensation under the QM points and fees test.