The Consumer Financial Protection Bureau revealed its much awaited ability-to-repay and qualified mortgage guidelines Wednesday, creating two types of qualified mortgages with different legal liability standards.
The first QM-loan classification includes a safe-harbor provision, which essentially eliminates 'ability-to-repay' litigation risk for qualified loans.
Essentially, the 'safe harbor' standard applies to lower-risk loans that meet all of the QM requirements.
The second-type of QM loan comes with a rebuttable presumption of safe lending and applies to higher-cost loans. This loan type is presumed safe for the most part, but can still be challenged on narrow grounds in court later on.
The overarching ability-to-repay rule also outlines the basic guidelines lenders issuing new loans will have to follow.
On the very basic level, the rule requires lenders to document and verify a borrowers employment status, income and assets, current debt obligations, credit history, monthly payments on the mortgage, and monthly pay-outs on other mortgages and debts. (Click here for a full fact sheet and underwriting criteria).The rule stipulates lenders can no longer offer no-doc, low-doc loans.
The final rule also forces lenders of qualified mortgages to determine if a borrower possesses sufficient assets or income to pay back the debt.
In addition, lenders are required to determine a borrower's ability-to-repay upfront by evaluating the consumer's debt-to-income ratio, earnings, expected earnings, current debt levels and the homeowner's ability to take on more debt.
The rule also is a death-knell for loans with teaser rates that have the potential to mask the true cost of a mortgage, the agency said.
Under ability-to-repay, lenders cannot base the evaluation of a consumer's ability to repay on teaser interest rates.
Instead, firms are required to determine a borrower's ability to repay both the principal and the interest over the long-term. In other words, using an introductory loan period when rates are generally lower will not suffice as an appropriate verification of a borrower's capacity to service the debt.
WHAT IS A QUALIFIED MORTGAGE?
The CFPB will presume lenders have complied with the ability-to-repay rule if lenders write a loan that fits within the agency's final definition of a 'qualified mortgage.'
The definition of a qualified mortgage is a loan that has no excess upfront points and fees. Qualified mortgages limit points and fees – including those used to compensate loan officers and brokers, the CFPB said.
A qualified mortgage cannot exceed 30 years, allow for interest-only payments, negative amortization payments or loans where the principal amount increases.
Qualified mortgages also have a cap on how much of a consumer's income can go towards a mortgage debt. A loan in which the borrower's debt-to-income ratio is less than or equal to 43% will generally be classified as a qualified mortgage.
Recognizing that transitioning to this standard will be somewhat burdensome, the CFPB created a temporary, transitional standard for loans that do not meet the '43%-or-under' DTI threshold. In the transition period, loans outside the DTI requirement will be 'qualified mortgages' as long as they meet other government affordability standards such as being eligible for acquisition by Fannie Mae and Freddie Mac.
The rule also prohibits loans with balloon payments from receiving QM status. There is an exeption for small creditors in rural or underserved areas as long as the lender originates balloon loans under specifically defined conditions.
QM's LEGAL RISKS
Once it's determined a borrower has received a qualified mortgage, lenders will need to know what legal risks apply to the mortgage.
The qualified mortgage rule with a safe-harbor provision protects lenders from 'ability-to-repay' legal liability for the life of the loan as long as the loan complies with the guidelines. Qualified mortgages with a safe harbor are those mortgages described as "lower-priced loans that are typically made to borrowers who pose fewer risks."
The CFPB added, "If the loan goes south, the lender will be considered to have legally satisfied the ability-to-repay requirements. But consumers can still legally challenge their lender under this rule if they believe that the loan does not meet the definition of a Qualified Mortgage."
The QM with a rebuttable presumption applies to "higher-priced loans typically for consumers with insufficient or weak credit history."
"If the loan goes south, the consumer can rebut the presumption that the creditor properly took into account their ability to repay the loan," the CFPB noted.
In that type of situation, the borrower would have to prove the creditor did not consider other factors like living expenses after calculating the mortgage and other debts.
Read the full ability to repay rule here.