America is changing. Because of the gig economy, underwriting practices of the past are becoming outdated. Similarly, more and more borrowers simply don’t reflect the profile of those from years gone by. Reforming the housing finance system is thus necessary as we progress deeper into the 21st century.
The rules and regulations governing mortgages continue to evolve as the Great Recession becomes a distant memory. In the crisis’ aftermath, Congress and other policymakers acted swiftly to protect consumers and ensure lenders operate in a safe and sound mortgage finance system, beneficial to everyone involved.
A key piece of the new regulatory environment was the creation of the Consumer Financial Protection Bureau and its Ability to Repay/Qualified Mortgage rule, which requires lenders to adequately verify a borrower’s ability to repay the mortgage.
This includes requirements, found in Appendix Q of the rule, mandating that lenders verify a borrower’s income and debts to ensure he or she has the ability to repay the loan. The rule also states that a borrower’s monthly debt-to-income ratio cannot exceed 43%.
There are, however, exceptions. Government-insured or -guaranteed loans (FHA, VA, USDA) are exempt from Appendix Q and the DTI threshold, as are any loans held in portfolio by banks or credit unions with $10 billion or less in assets.
The CFPB also determined that any loan backed by GSEs, meaning Fannie Mae or Freddie Mac, was eligible for QM status, which means the loan would also be exempt from these Appendix Q and DTI requirements.
This particular exemption is known as the GSE QM patch. This patch is scheduled to expire in January 2021. To be sure, in the long run, it is preferable to do away with the patch so as to provide a more level playing field between GSE and non-GSE loans.
Simply allowing the patch to expire without any reforms, however, could be catastrophic.
Over one-quarter of the GSEs’ recent single-family volume consists of loans with DTI ratios above 43% – loans that would no longer qualify as QM loans were the patch to disappear. This would lead to a cliff event in which many of those loans would shift to another form of government backing – such as FHA – or simply not be made at all.
According to the Urban Institute, high-DTI GSE borrowers are disproportionately minorities. African Americans are 29% more likely to have an over-43% DTI loan than an under-43% DTI loan. Similarly, Hispanics are 38% more likely to have a high-DTI loan. These are the borrowers who would be most impacted by the expiration of the patch.
This is why the CFPB should reform the ATR/QM rule before any expiration of the patch. MBA believes that this reform should address Appendix Q and the 43% DTI threshold.
With respect to Appendix Q, the preferred policy solution is embodied within bipartisan legislation introduced in the Senate by Mark Warner (D-VA) and Mike Rounds (R-SD) earlier this year and by Reps. Tom Emmer (R-MN) and Bill Foster (D-IL) in the House.
This proposal would better allow lenders to qualify self-employed borrowers for QM loans outside of the GSEs or the government agencies. Many of these individuals already have the ability to repay a mortgage, but because they’re self-employed or have non-traditional sources of income, they too often cannot qualify for loans outside of the government-backed channels.
This legislation would permit lenders to move away from the outdated, static requirements of Appendix Q and instead document borrower income and debt through the government-approved methodologies already in place in the GSE guides or the FHA, VA, and USDA handbooks.
With respect to the 43% DTI threshold, it makes little sense to commit to a rigid requirement that does not account for the complexities of underwriting. Instead, we should focus on alternatives, like permitting the use of compensating factors or implementing a residual income test.
Allowing for this flexibility will ensure that lower-income borrowers and minorities are better able to participate in the home-buying process, without introducing undue risk to the system.
Given that a CFPB rulemaking to institute these reforms would be a lengthy process, we expect there will need to be a short-term extension of the patch to ensure a smooth transition.
If the patch is to be extended temporarily, it should be expanded to provide QM safe-harbor status to more private loans, including jumbo loans that would otherwise be eligible for sale to the GSEs if not for their size.
The future is unwritten, but the past tells us we must change with the times in order to meet the demands of changing generations. Now is the time to address the needed changes to our system. Targeted reforms to the QM standard would represent a significant step forward, promoting sustainable homeownership for more qualified borrowers across the country.