WASHINGTON — The Consumer Financial Protection Bureau released its long-awaited final rule on Thursday to establish new standards for all mortgages, including carving out a certain segment of loans called "qualified mortgages" that are deemed ultrasafe.
Much of the rule was as industry observers expected it, but the final regulation had some unexpected twists, including giving lenders a safe harbor legal protection for QM loans, but only for prime loans.
The bureau also designed the rules to allow more loans to attain "qualified mortgage" status, making it less restrictive than many lenders had initially expected.
"Our goal here is not only to stop reckless lending, but to enable consumers to access affordable credit," said CFPB Director Richard Cordray in prepared remarks to be delivered Thursday in Baltimore. "We can draw up the greatest consumer protections ever devised, but if consumers cannot get credit, then there is nothing to protect."
American Banker offers the following guide to the many provisions of this complex and important rule, including a breakdown of what qualifies as QM and how the regulation will treat loans owned by the government-sponsored enterprises.
Ability to Repay
The basic premise of the rule will require lenders to ensure borrowers have the ability to repay a loan.
To do this, lenders must verify eight underwriting standards including: current income or assets; employment status; credit history; monthly payments on the mortgage as well as any other mortgage-related obligations and loans associated with the property; other debt obligations and the monthly debt-to-income ratio.
As a result, the rule effectively eliminates the use of so-called no-doc or low-doc loans. It also prevents lenders from basing ability-to-repay decisions on teaser rates, instead requiring them to base it on the principal and interest of the mortgage over its life.
"The core of the ability-to-repay rule rests on two basic, common-sense precepts: lenders have to check on the numbers and make sure that the numbers check out," Cordray said. "Borrowers no longer will be sold mortgages that are predestined to fail."
The rule also allows lenders to refinance existing risky mortgages such as interest-only and adjustable-rate loans to a "more stable, standard loan" without having to meet the full underwriting process under the new rules.
Finally, the rule also bans prepayment penalties for certain fixed-rate, qualified mortgages and requires lenders to keep records demonstrating they have complied with the ability-to-repay rule for at least three years.
The ability-to-repay rule is expected to take effect Jan. 10, 2014.
Arguably the most important part of the final rule, the regulation also defines a new category of loans, "qualified mortgages," that are guaranteed to comply with the ability-to-repay requirements.
Generally speaking, these are the characteristics of a QM loan:
a) The borrower has a debt-to-income ratio no greater than 43%.b) Fees and points cannot exceed 3% of the total loan amount, although certain "bona fide" fees on prime loans are excluded.
c) Lenders must verify a borrower's income.
d) The loan cannot include certain characteristics of nontraditional mortgages, including interest-only and negative-amortization loans, as well as mortgages for a period of longer than 30 years.
Of those requirements, the most important is arguably the new DTI standard.
"No standard is perfect, but this standard draws a clear line that will provide a real measure of protection to borrowers and increased certainty to the mortgage market," Cordray said.
In his remarks, he noted a California homeowner named "Henry" who contacted the bureau after his home was foreclosed on. The kicker was that Henry received a mortgage for a home sold at more than half a million dollars based on his salary of $50,000.
"This kind of reckless lending was an endemic problem," Cordray said. "I firmly believe that if the ability-to-repay rule we are announcing today had existed a decade ago, many people like Henry could have been spared the anguish of losing their homes and having their credit destroyed."
While the industry has yet to respond in detail on the rule, however, some were already raising concerns that the QM definition was overly harsh.
"The 3% cap on points and fees appears to be overly inclusive, and would result in some loans exceeding the limit simply because the borrower used a mortgage broker, or chose settlement services from a provider affiliated with the lender," Debra W. Still, chairman of the Mortgage Bankers Association, said in a press release.
One of the biggest questions industry watchers had was whether QM status gives lenders a legal safe harbor ensuring they could not be sued for violating the ability-to-repay loan, or whether it was just a "rebuttable presumption" of compliance.
The final rule essentially splits the baby, proposing to give safe harbor protection to all prime QM loans, but give only a rebuttable presumption to higher-priced QM loans, which are essentially subprime mortgages.
The CFPB said that distinction is similar to underwriting requirements established by the Federal Reserve Board in 2008 for higher-priced loans, but the consumer agency said it sought to be more detailed about what basis a consumer might have to launch a legal challenge.
"Specifically, the final rule provides that consumers may show a violation with regard to a subprime qualified mortgage by showing that, at the time the loan was originated, the consumer's income and debt obligations left insufficient residual income or assets to meet living expenses," the bureau said in its summary. "The analysis would consider the consumer's monthly payments on the loan, loan-related obligations, and any simultaneous loans of which the creditor was aware, as well as any recurring, material living expenses of which the creditor was aware."
Prime loans meeting the QM criteria, however, would get a safe harbor, meaning it is "conclusively presumed that the creditor made a good faith and reasonable determination of the consumer's ability to repay," the summary said.
Still, the bureau indicated even for loans receiving a safe harbor, borrowers may have legal avenues to argue lenders did not do all their homework.
"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 bureau said in a fact sheet accompanying the rule. "This does not affect the rights of a consumer to challenge a lender for violating any other federal consumer protection laws."
In its summary, the CFPB acknowledged one of the industry's greatest fears about the QM rule: no one is going to make loans that fall outside of those criteria. As a result, it said it would allow temporary flexibility for DTI requirements for seven years or until Congress passes housing finance reform, whichever happens first (Given lawmakers lack of appetite for this subject, seven years is a pretty safe bet.)
This means that loans that generally meet QM criteria (but not necessarily the 43% DTI ratio) will be presumed to meet QM if they also satisfying the underwriting requirements for loans insured by Fannie Mae and Freddie Mac or the federal government.
For now, it also means the final rule will continue the dominance of GSE-owned mortgages in the market, at least until policymakers enact housing finance reform.
Loans with balloon payments are generally not considered QM loans, except for those made by smaller lenders in rural and underserved communities.
Under the rule, a lender must have no more than $2 billion of assets and make at least half of its first-lien mortgages in counties considered rural and underserved. Loans must also have terms of at least five years, fixed interest rates and meet certain basic underwriting criteria.
Such lenders must also consider DTI ratios as part of underwriting requirements, but do not have to comply with the 43% ratio.
The CFPB said it will produce a list each year of rural and underserved counties.