In January, the Consumer Finance Protection Bureau passed a set of new, more stringent regulations. The 800-page document, most commonly labeled as the Ability-to-Repay Rule, was created in response to the flood of foreclosures caused by the financial crisis. This collection of regulations requires mortgage lenders to make good-faith efforts to ensure that all borrowers have the ability to repay their new loans.
Although more responsibility is being placed on the lender to access the borrower’s ability to repay the mortgage based on defined criteria, the Ability-to-Repay Rule has been designed to add a new layer of protection for consumers, mortgage lenders and brokers. This new rule is effective January 2014 and has been prompted by the large number of foreclosures on “teaser rate” adjustable rate mortgages, “no documentation” qualifying and the proliferation of “interest only” mortgages issued by many lenders before 2007.
Although there were additional CFPB rules released in January, and even more to come, the Ability-to-Repay Rule is at the core of the movement for future loan origination. Lenders preferred an approach where greater priority was placed on the experience and knowledge of industry underwriters to provide a more equitable approach to a borrower’s ability to repay. There are many factors that contribute to the borrower’s financial stability and ability to repay their mortgage and other debts, with no one factor determining whether repayment is likely or not. However, the CFPB opted to focus on the most transparent factor by placing a bright white line on the debt-to-income ratio.
A key element of the rule is that new loans should not put a borrower above a 43% debt-payment-to-income ratio. That is, the total amount of monthly debt obligations a borrower will have after the proposed mortgage is included cannot be greater than 43% of the borrower’s pretax income.
If the borrower meets the criteria established by the Ability-to-Repay Rule, the mortgage is deemed a Qualified Mortgage. As the new rules protect the borrower, a Qualified Mortgage also protects the lender should the borrower default on the loan. Congress has directed that the Ability-to-Repay Rule include such provisions that would help shield lenders adhering to the guidelines if challenged in court by providing a safe harbor for loans that fit the QM criteria that are not categorized as “higher-price loans.”
Here are the highlights of the qualified mortgage loan:
It must be a full documentation loan. Lenders must look at a consumer’s financial records and verify them. All documentation must be obtained and reviewed and copies must be secured in the borrower’s mortgage folder and available for audit.
The borrower must have sufficient assets and income to pay the loan payment. Lenders must make the determination of whether or not the borrower can repay the loan by fully documenting borrower’s income along with any assets they have on hand.
No excessive upfront points and fees. Points are still allowed to be purchased and paid by the borrower for a bonafide reduction in rate; however, the fees excluding these points must not exceed 3% of the total amount borrowed, if the loan is to be considered a qualified mortgage.
No interest-only, negative-amortization, no term longer than 30 years. These include mortgage products where the borrower defers the repayment of principal and pays only the interest, usually for a certain period of time. Furthermore, all loans must have a repayment of 30 years or less.
The maximum DTI (debt-to-income) ratio is 43%. The debt-to-income ratio compares the amount of money a person earns each month (gross monthly income) to the amount he or she spends on recurring debt obligations. This aspect of the QM rule is intended to prevent consumers from taking on mortgage loans they cannot realistically afford.
No balloon payments (except for smaller creditors in rural and underserved areas). Balloon mortgages are ones that have a larger-than-normal payment at the end of the repayment term. Although prohibited in many areas, smaller lenders in ‘rural or underserved areas’ may still make such loans.
There is a temporary category for QM that will allow for more flexible underwriting criteria through the approval guidelines and Automated Underwriting Software of the GSEs while under Federal conservatorship, the Department of Housing and Urban Development, Department of Veterans Affairs, Department of Agriculture or Rural Housing Service. If these entities will approve and purchase the mortgage, the loan will be categorized as a Qualified Mortgage during this temporary period. This temporary period will phase-out as these agencies provide their own definition of qualified mortgages, upon the end of the GSE conservatorship, or no later than seven years.
The CFPB recently announced an implementation plan that will include a coordinated effort to ensure all regulators have an understanding of the new rules for future audits in addition to helpful resources like “easy-to-understand” guides and summaries, video education “how-tos,” and publishing updates with interpretation and readiness guides.
Lastly, we applaud that the CFPB made a commitment to educate potential homeowners about their new protections under these rules with a widespread consumer education program.
Marcus McCue is an executive vice president at Guardian Mortgage Company. The opinions expressed above are his own.