5 changes lenders want from CFPB’s rewrite of QM rule

WASHINGTON — The Consumer Financial Protection Bureau should not hold back in revamping its mortgage underwriting rule, according to public comment letters from the industry.

The effects of that rule, which requires lenders to verify borrowers' ability to repay and provides legal protection for "qualified mortgages" with low debt-to-income ratios, so far has been limited. That is because Fannie Mae- and Freddie Mac-backed loans are automatically QM regardless of their DTI thanks to a temporary exemption known as the "patch."

But with the CFPB planning to end the patch, lenders want the agency to aim high as it seeks to change the QM rule across the industry. The 93 letters responding to the bureau's request for input call for removing the 43% DTI limit from QM. Lenders are also seeking the elimination of Appendix Q, a set of guidelines for documenting a borrower's income and other underwriting factors. They also back a short-term extension of the Fannie and Freddie patch.

Here are five arguments that commenters make in letters to the CFPB:

Extend the patch on a short-term basis

Fannie Mae's headquarters
CFPB Director Kathy Kraninger has said the CFPB intends to shift away from the patch or consider only a short extension to “facilitate a smooth and orderly transition” for mortgages backed by the government-sponsored enterprises.

Commenters urged her agency to pursue the latter. They noted the regulatory and possible housing market impact of a slice of Fannie Mae and Freddie Mac loans no longer having QM status. The patch is now set to end in January 2021.

“Considering the numerous steps that need to occur, and the challenges across many industries — notably including the homebuilding industry and the secondary market — while the expiration date for the patch looms, we urge that a sufficient extension of the patch be announced along with the plan,” wrote Kenneth Gear, the CEO of the Leading Builders of America, in a comment letter.

The amount of time the market needs to prepare for that sunset will be determined by the complexity of the CFPB’s final rule on QM change, said Michael DeVito, executive vice president and head of home lending at Wells Fargo.

“Eliminating DTI and Appendix Q would require the least amount of time (with the caveat that timing may increase if additional factors are introduced),” he said in the bank’s comment letter. “Eliminating the Patch and retaining the DTI cap and Appendix Q in one form or another — which we believe would be detrimental to the market — would require more time.”

The January 2021 expiration of the patch will also be complicated by the transition to a new interest rate benchmark the same year, DeVito added, and banks might need more time to prepare.

“In addition to the GSE Patch, LIBOR also sunsets in 2021 and will require significant technology resources through that date,” said DeVito. “Additionally, the timing of possible changes to the Home Mortgage Disclosure Act and Uniform Residential Loan Application remain uncertain and could overlap.”

A short-term extension would also give the CFPB more time to research alternative ways to measure a borrower’s ability-to-repay, according to a comment letter filed jointly by a number of consumer protection organizations, including the National Consumer Law Center and the National Association of Consumer Advocates.

“The Bureau could leverage [the Federal Housing Finance Agency’s] expertise and effort in adjustments to the patch while the Bureau develops a stable, long-term solution and a transition plan,” those commenters suggested.

Avoid adverse effects for lower-income borrowers

Senator Sherrod Brown, D-Ohio.
If the CFPB were to end the QM patch without some kind of replacement, it would be detrimental to lower-income and minority borrowers, several commenters warned.

“If lenders remain unwilling to originate loans for average families without full liability protection, this could further restrict access to credit for borrowers of color, who represent a disproportionate share of QM patch loans and remain underserved by conventional mortgage credit,” wrote a group of nine Democrats on the Senate Banking Committee, including ranking member Sherrod Brown, D-Ohio, and Sen. Elizabeth Warren, D-Mass.

The consortium of consumer advocacy groups also recommended that the CFPB conduct thorough analysis of how any changes might impact minorities.

“There is a real risk that hasty or ill-considered action by the Bureau in adjusting the Qualified Mortgage definition could make access to credit worse for communities of color and low-income communities, either immediately with a market shock that severely restricts access to these traditionally underserved communities or over a longer term by blessing predatory practices that further strip wealth from these communities,” the groups said.

While the CFPB’s advance notice of proposed rulemaking suggested that borrowers with a DTI of above 43% might obtain a non-QM loan, the Mortgage Bankers Association cautioned that that wouldn’t be a realistic option for many lower-income borrowers.

The organization cited the CFPB’s own finding that non-QM loans are priced about 119 basis points higher than similar QM loans.

“Should the expiration of the GSE Patch prompt growth in the non-QM market, it would likely do so at the expense of borrower affordability,” wrote Robert Broeksmit, MBA president and CEO. “Such a result would be inconsistent with the Rule’s underlying statutory purpose to ensure consumer access to affordable mortgage credit.”

And if lenders are unwilling to originate or purchase non-QM loans, a large swath of borrowers would be completely cut out of the mortgage market, Broeksmit added.

“At roughly one-sixth of the overall mortgage market, eliminating even a portion of this segment would have harmful effects on access to credit generally and significant economic implications, extending well beyond the housing market,” he said.

The CFPB absolutely must address where those loans that exceed the DTI limit “would go, if they would be made at all, and on what terms, before the expiration of the patch,” the NCLC and NACA, along with other organizations, wrote in their comment letter.

“Abandoning the patch, as the Bureau has said it intends to do, while leaving in place a hard DTI cut off would be a serious blow to both congressional intent and to practical access to home finance for millions of qualified borrowers, especially borrowers of color,” the groups said.

Remove DTI from the QM equation

CFPB Director Kathy Kraninger
Kathy Kraninger, director of the Consumer Financial Protection Bureau (CFPB), smiles during a discussion at the Bipartisan Policy Center in Washington, D.C., U.S., on Wednesday, April 17, 2019. Kraninger, confirmed in December by the Senate, took over an agency created by the 2010 Dodd-Frank Act that regulates everything from credit cards to mortgages. Photographer: Andrew Harrer/Bloomberg
Most commenters to the CFPB agreed that the 43% DTI limit should be eliminated entirely and replaced by either compensating factors to assess a borrower’s ability to repay or a higher threshold.

“The simplest reform that the Bureau could undertake would be to remove the DTI ratio threshold,” wrote Broeksmit in MBA’s comment letter. “This approach would effectively set the parameters of the QM general definition as the various product feature requirements currently in place.”

This would ensure that all borrowers would be able to maintain access to credit, agreed the Credit Union National Association in its comment letter.

“CUNA firmly believes that eliminating rigid adherence to the 43% debt-to-income ratio and Appendix Q verification requirements in the underlying qualified mortgage definition would enable credit unions to continue providing access to responsible mortgage credit without introducing additional credit risk into the marketplace,” wrote Mitria Wilson, the group’s senior director of advocacy and counsel.

When the CFPB announced the ANPR, Kraninger suggested changes to the DTI level are on the table.

"We’re taking comment on a few things, first and foremost what that definition of a qualified mortgage would be after the patch is gone, including what debt-to-income ratio looks like, what the ratio should be ... in terms of that QM definition, whether 43% DTI is something that makes sense to continue," she said.

The National Association of Realtors suggested using both DTI and residual income to assess a borrower’s ability to repay.

“NAR supports a QM standard that incorporates a reasonable DTI ratio in conjunction with other factors,” wrote NAR President John Smaby. “Borrowers should have enough residual income after making their monthly mortgage payment, including taxes and insurance, to meet their needs for food, utilities, clothing, transportation, work-related expenses and other essentials.”

Other organizations also appeared to approve of the idea of using compensating factors either instead of or in tandem with a borrower’s DTI ratio.

“While there are many variants of compensating factors, the basic premise is that QM status would be determined through a more holistic view of the consumer’s personal finances and the features of the loan,” said Broeksmit. “This approach ensures that a DTI ratio is not the sole reason that a loan fails to achieve QM status.”

The Leading Builders of America also proposed analyzing factors such as “cash reserves, equity in the property, credit as well as reserves, debt and income.”

“Using these and other factors would clearly allow a more holistic view of the consumer’s ability to repay,” said Gear.

However, Gear advised against using credit scores and loan-to-value ratios, arguing that they could have “unintended consequences.”

“We believe employing an LTV alone as a substitute for DTI would severely disadvantage consumers in many areas where housing prices are low,” he said. “Beyond that, considering the profound differences in wealth across protected classes, we believe the use of LTV alone is likely to present significant Fair Housing Act concerns.”

Using credit scores could also “raise fair lending concerns,” he said.

Eliminate Appendix Q

HUD building
Signage stands outside the U.S. Department of Housing and Urban Development (HUD) headquarters in Washington, D.C., U.S., on Friday, Aug. 23, 2019. HUD this year accused Facebook Inc. of enabling and encouraging bias based on race and religion by restricting who can see housing-related ads on its platforms and across the internet. Photographer: Andrew Harrer/Bloomberg
Under the QM rule, lenders must document a borrower’s income, assets, savings and debt using eight criteria known as Appendix Q. The standards in Appendix Q are adapted from guidelines used by the Federal Housing Administration.

Appendix Q could be modernized, but several commenters suggested that such a process wouldn’t even be worth it, and instead recommended that that portion of the QM rule be scrapped.

“As the industry and the economy continue to evolve, mortgage underwriting needs to keep pace to adequately serve a broad spectrum of consumers in a responsible manner,” said Broeksmit. “This flexibility is simply not possible when a requirement such as Appendix Q is only reviewed and updated every few years.”

Guidelines developed by other agencies, like the Department of Housing and Urban Development as well as Fannie Mae and Freddie Mac, “do a better job of underwriting loans for the growing cohort of borrowers of all ages, particularly millennials, with irregular income in the ‘gig’ economy,” said Gear.

Wells Fargo’s DeVito agreed that Appendix Q is outdated.

“Appendix Q does not serve as an effective underwriting methodology for multiple segments of credit-worthy consumers, including the self-employed, retirees and borrowers with variable incomes; nor is it adequately dynamic to respond to market changes or technology innovations,” he said.

The MBA recommended that the CFPB develop its own income and debt verification standards as well as “allow the use of existing income and debt verification standards maintained by other entities to calculate a DTI ratio subject to a threshold prescribed by the Bureau.”

“Because the government and GSE standards are widely used and accepted, this option should result in quick industry adoption,” said Broeksmit. “Creditors would be able to leverage systems that are already in place, which would require little in terms of new infrastructure, processes, or training.”

While NAR didn’t take a position on what the CFPB should do with Appendix Q, the group pushed for a less rigid set of standards.

“NAR believes that a standard for determining a borrower’s ability to repay must be flexible to accommodate borrowers with unique income streams and life circumstances,” said Smaby.

Some organizations also argued that Appendix Q makes it more difficult for lower-income borrowers to obtain QM loans.

“After the Patch expires, the best way to enable fair market competition across all lending channels to continue, while also ensuring that creditworthy individuals can be served in a safe and sound manner under the existing framework, is to eliminate the debt-to-income ratio for prime and near-prime loans and, with it, Appendix Q,” said CUNA’s Wilson.

Lenders want stronger liability protection for QM loans, but consumer advocates disagree

Courthouse sign
The U.S. federal courthouse stands in Seattle, Washington, U.S., on Thursday, Feb. 28, 2019. Huawei Technologies Co. and its U.S. affiliate were ordered to appear in federal court in Seattle to face charges that they engaged in a scheme to steal trade secrets of T-Mobile US Inc. Photographer: Chona Kasinger/Bloomberg
A portion of the public comments deal with the amount of legal protection loans receive if they have QM status.

Under the rule, certain QM loans have a full safe harbor, while others have a "rebuttable presumption" that they are in compliance. The latter still gives borrowers an opening to bring legal claims against a lender.

In its advance notice of proposed rulemaking, the CFPB asked for feedback on whether the agency should maintain that distinction.

“Assuming without deciding that the Bureau were to adopt standards that do not directly measure a consumer's personal finances, should the Bureau retain the current line separating safe-harbor and rebuttable-presumption QMs or modify it and, if so, how?” the agency asked.

In answering that question, commenters were split.

NAR maintained that the QM rule should provide a way to dismiss “non-meritorious cases” so originators aren’t faced with overly burdensome litigation.

“As a result, establishing the QM as a rebuttable presumption would be of very limited value to originators and investors in defending ability‐to‐pay litigation, even when making only qualified mortgages,” wrote Smaby. “Every borrower complaint filed — even a meritless one — has the potential to cost the originator or investor tens of thousands of dollars to defend or settle.”

But consumer advocates argued in their joint letter that a safe harbor puts consumers at risk.

“Permitting creditors to take advantage of an absolute safe harbor from liability, examination, or enforcement of the Dodd-Frank Act ability to repay requirements, without some mandated and verifiable consideration of ability to repay, invites abuse,” wrote the organizations.