Dear CFPB: Let the QM ‘patch’ expire
The “qualified mortgage” rule is back on everyone’s minds following the Consumer Financial Protection Bureau’s request for information in 2017 and a subsequent assessment of the rule published this January.
One issue is a temporary provision of the QM Rule, known as the “patch,” which allows Freddie Mac and Fannie Mae to exceed the QM debt-to-income test. The patch will automatically expire in January 2021 — or whenever the government-sponsored enterprises are discharged from receivership. Given that the latter outcome is unlikely in the near term, the bureau should state as soon as possible that the patch will be allowed to expire as intended in order to allow for an orderly market adjustment over the next 19 months.
The patch has been, and continues to be, a major contributor to the current home price boom, particularly for entry level homes. As such, first-time buyers have been particularly disadvantaged. Allowing the patch to expire would reduce upward pressure on house prices in the near term and retaining the QM rule’s DTI test would prudently apply countercyclical friction during “hot” housing markets in the future. Consistent with the intent of the QM Rule, limits on DTIs also protect borrowers from taking on excessive mortgage risk. This is particularly relevant for first-time homebuyers.
The American Enterprise Institute mortgage risk index finds that first-time-buyer loans above 43% DTI are riskier than first-time-buyer loans with 39-43% DTI, while repeat buyers don’t exhibit such risk layering. Allowing the patch to expire would help to protect borrowers and taxpayers alike and would implement the bureau’s original intent to create a common 43% DTI QM maximum for all conventional lending, including at the GSEs.
At the same time, the bureau should announce its intention to issue guidance to lenders, investors and most other market participants prior to January 2021, so as to address perceived compliance ambiguity and uncertainty in parts of the regulation.
It is this uncertainty that leads to an increased perception of risk by non-GSE lenders and mortgage investors. Addressing this uncertainty with added guidance could help eliminate the current practice of using the automated underwriting systems at the GSEs to obtain an approval for QM status. This alone is a positive step, because it would reduce the over-reliance on the GSEs for regulatory guidance. It would also serve to remove unintended consequences relating to the original text and the bureau’s decision to avoid providing guidance regarding specific language and fact patterns relating to the rule. In particular, the bureau should provide updated guidance within §1026.43 and Appendix Q, so as to provide lenders and the secondary market with the certainty of execution.
As a supplement to providing guidance, the bureau should also announce well before January 2021 its intention to implement a “no action” letter approach, similar to what is already in place at the Securities and Exchange Commission and what was recently proposed by the bureau with regards to fintech innovation.
This approach should be made operational before the January 2021 patch expiration. Lenders or vendors could then come up with processes, analyses and algorithms which would form the basis for seeking no-action letters. That could include, for example, submission of a process based on commercial banking relationships with self-employed borrowers whereby the commercial bank uses the borrower's other in-house accounts as a means of providing evidence about the stability of income.
The goal would be for firms to identify ways of documenting qualifying income and its stability, as well as for liabilities. A lender's underwriting process can rely on this information as inputs. Based on the income and liability inputs from the approved process, the lender would calculate a debt-to-income ratio — and if less than 43%, that would create the legal basis for a qualified mortgage.
Further, the bureau should assure market participants that it has the capacity to scale the no-action-letter approach and to respond to firms within a clear timeframe. To this end, the greater clarity the bureau provides in its guidance, the less need there will be for no-action letters. If it finds common no-action themes, these could also be turned into general guidance.
It’s important to underscore that letting the patch expire will not result in fewer homes being sold and home loan purchase volume will be largely unchanged. This is because we continue to experience one of the strongest sellers’ markets in history, especially for entry-level homes. But given the shortage of entry-level supply, it is not a question of whether entry-level homes will sell, but at what price? Letting the patch expire on time will help reduce upward pressure on home prices.