Thursday, January 10, 2013

CFPB Final Rule QRM and Ability to Repay - Interpretation


The Consumer Financial Protection Bureau is issuing a final rule to implement laws requiring mortgage lenders to consider consumers’ ability to repay home loans before extending them credit. The rule will take effect on January 10, 2014.


During the years preceding the mortgage crisis, too many mortgages were made to consumers without regard to the consumer’s ability to repay the loans. Loose underwriting practices by some creditors including failure to verify the consumer’s income or debts and qualifying consumers for mortgages based on “teaser” interest rates that would cause monthly payments to jump to unaffordable levels after the first few years contributed to a mortgage crisis that led to the nation’s most serious recession since the Great Depression.
In response to this crisis, in 2008 the Federal Reserve Board ,Board, adopted a rule under the Truth in Lending Act which prohibits creditors from making “higher-price mortgage loans” without assessing consumers’ ability to repay the loans. Under the Board’s rule, a creditor is presumed to have complied with the ability-to-repay requirement if the creditor follows certain specified underwriting practices. This rule has been in effect since October 2009.

In the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act, Congress required that for residential mortgages, creditors must make a reasonable and good faith determination based on verified and documented information that the consumer has a reasonable ability to repay the loan according to its terms. Congress also established a presumption of compliance for a certain category of mortgages, called “qualified mortgages.”

Summary of Final Rule

Ability-to-Repay Determinations. The final rule describes certain minimum requirements for creditors making ability-to-repay determinations, but does not dictate that they follow particular underwriting models.  

At a minimum, creditors generally must consider eight underwriting factors:
1.  Current or reasonably expected income or assets;
2.  Current employment status;
3.  The monthly payment on the covered transaction;
4.  The monthly payment on any simultaneous loan; (5) the monthly payment for mortgage-related obligations;
6.  Current debt obligations, alimony, and child support;
7.  The monthly debt-to-income ratio or residual income; and
8.  Credit history. Creditors must generally use reasonably reliable third party records to verify the information they use to evaluate the factors. 

The rule provides guidance as to the application of these factors under the statute. For example, monthly payments must generally be calculated by assuming that the loan is repaid in substantially equal monthly payments during its term. For adjustable-rate mortgages, the monthly payment must be calculated using the fully indexed rate or an introductory rate, whichever is higher. Special payment calculation rules apply for loans with balloon payments, interest-only payments, or negative amortization.

The final rule also provides special rules to encourage creditors to refinance “nonstandard mortgages” which include various types of mortgages which can lead to payment shock that can result in default into “standard mortgages” with fixed rates for at least five years that reduce consumers’ monthly payments.

Presumption for Qualified Mortgages. The Dodd-Frank Act provides that “qualified mortgages” are entitled to a presumption that the creditor making the loan satisfied the ability to repay requirements.  
General Requirements for Qualified Mortgages. The Dodd-Frank Act sets certain product-feature prerequisites and affordability underwriting requirements for qualified mortgages and vests discretion in the Bureau to decide whether additional underwriting or other requirements should apply.  

The final rule implements the statutory criteria, which generally prohibit loans with negative amortization, interest-only payments, balloon payments, or terms exceeding 30 years from being qualified mortgages.  So-called “no-doc” loans where the creditor does not verify income or assets also cannot be qualified mortgages.
Finally, a loan generally cannot be a qualified mortgage if the points and fees paid by the consumer exceed three percent of the total loan amount, although certain “bona fide discount points” are excluded for prime loans.  

The general rule requires that monthly payments be calculated based on the highest payment that will apply in the first five years of the loan and that the consumer have a total (or “back-end”) debt-to-income ratio that is less than or equal to 43 percent unless GSEs or HUD apply flexible underwriting standards.  In that case the ratios would conform more to current LP and DU guidelines. 

Bureau is concerned that creditors may initially be reluctant to make loans that are not qualified mortgages, even though they are responsibly underwritten. The final rule therefore provides for a second, temporary category of qualified mortgages that have more flexible underwriting requirements so long as they satisfy the general product feature prerequisites for a qualified mortgage and also satisfy the underwriting requirements of, and are therefore eligible to be purchased, guaranteed or insured by either (1) the GSEs while they operate under Federal conservatorship or receivership; or (2) the U.S. Department of Housing and Urban Development, Department of Veterans Affairs, or Department of Agriculture or Rural Housing Service. This temporary provision will phase out over time as the various Federal agencies issue their own qualified mortgage rules and if GSE conservatorship ends, and in any event after seven years. 

Other Final Rule Provisions. The final rule also implements Dodd-Frank Act provisions that generally prohibit prepayment penalties except for certain fixed-rate, qualified mortgages where the penalties satisfy certain restrictions and the creditor has offered the consumer an alternative loan without such penalties.


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