The Consumer Financial Protection Bureau is working to finalize the definition of a Qualified Mortgage under the forthcoming ability-to-pay regulations. These regulations will have profound implications for the entire U.S. residential mortgage market.
In order to ensure consumers have wide access to affordable mortgage credit, the final QM rule must include three important elements: a broad QM definition to capture most of the high quality, well-underwritten loans being made today; clearly defined, objective standards; and a compliance safe harbor for lenders.
Industry and consumer groups alike agree that the final QM must be broadly defined and contain clear definitions in order promote sound underwriting and a robust housing market. But these two elements are not enough.
To ensure that the consumer benefits of a broadly defined QM are not defeated by legal uncertainty, the QM must include a safe harbor that affords lenders real protections when making the types of loans that government policy clearly seeks to encourage. Without a safe harbor, the market will restrict lending in response to heightened litigation risk and threaten a delicate housing recovery.
Under the Dodd Frank Act, the liability for violating the ability-to-repay standard is intended to be harsh. The law provides borrowers and their counsel a strong arsenal to stop foreclosure, obtain substantial compensation, and cover the attorney's fees. Adding such a significant element of legal risk to every underwriting decision a lender makes, and to every loan an investor buys, has the potential to drive capital away from the mortgage market.
Recognizing this, Congress created the QM and granted legal protections to lenders making these loans in order to establish QMs as the "preferred" product in the market. Under this incentive structure, borrowers would seek out QMs, and lenders would make them widely available; conversely, lenders that originate non-QMs would be subject to significantly enhanced legal risks.
However, for this incentive structure to work properly there needs to be a significant difference in the legal risks between QMs and non-QMs. Policymakers are grappling with two different approaches.
One option would establish a rebuttable presumption for lenders originating a QM loan. In litigation, this means lender initially is presumed to have properly established a borrower's ability to repay their mortgage. But under other areas of truth-in-lending that utilize a presumption, borrowers have had little trouble overcoming this hurdle. As a result, a rebuttable presumption would expose lenders to substantial litigation risk even when they originate loans that meet all the requirements of the QM definition.
If the QM is a rebuttable presumption, lenders will be forced to take additional steps to protect against meritless litigation, primarily by tightening credit standards well inside those established by the QM definition itself. These "credit overlays" will prevent thousands of otherwise creditworthy borrowers from purchasing a home or refinancing into a lower rate loan. Borrowers with modest credit blemishes, lower financial reserves or nontraditional income sources (e.g., tips, boarder income, self employment, etc.) will be hit hard — a burden that will fall most heavily on low- and moderate-income borrowers and communities.
Additionally, a QM established as a rebuttable presumption could alter the competitive landscape in the mortgage market. Smaller, community-based lenders do not maintain the in-house legal resources to manage frequent litigation and cannot afford the settlements required to dispense with meritless claims. They will be forced to tighten standards further or exit the market. In the end, the QM as a rebuttable presumption will likely further increase consolidation in the mortgage market into the hands of just a few lenders.
The better option for the bureau would be to establish the QM as a safe harbor. A safe harbor with clear, objective standards will provide lenders and investors with an affirmative defense to defeat non-meritorious claims early in the legal process.
Eliminating litigation uncertainties should reduce lenders' and investors' reliance on credit overlays that have contributed to excessively tight underwriting standards. Over time, the certainty of a safe harbor would discourage meritless claims, keep costs lower for lenders and consumers, and reduce or eliminate costly credit overlays. In short, a safe harbor would bring to the mortgage market predictability in lending standards that a rebuttable presumption simply cannot.
An effective ability to repay rule needs to provide strong incentives for lenders to focus on making well-underwritten QMs affordable, and abundantly available, to all creditworthy borrowers. This will require both a legal safe harbor for lenders and investors, and a clear, objective definition of the QM itself.
Glen Corso and Pete Mills are managing directors of the Community Mortgage Banking Project, which represents independent mortgage banking companies in Washington.