Editor’s note: This feature originally appeared in the December issue of MReport.
This past summer, the Consumer Financial Protection Bureau (CFPB) reopened a highstakes rulemaking that is expected by many to redefine the requirements for the Qualified Mortgage (QM) under the Ability to Repay/ Qualified Mortgage Rule (ATR/ QM Rule or Rule). When the rulemaking process closes, a new definition is expected to establish the criteria that most borrowers will have to meet to obtain the most affordable housing credit for years to come.
On July 25, 2019, in an Advance Notice of Proposed Rulemaking (ANPR), the CFPB announced, to the surprise of many, that it planned to allow the “Temporary GSE QM” or “Patch” to expire at the beginning of 2021. The Patch enables mortgage loans eligible for purchase or guarantee by Fannie Mae or Freddie Mac (the GSEs) to be treated as QMs. The ANPR invited comments on the possibility of a short extension of the Patch for an “orderly transition.” More importantly, for the long term, the ANPR also invited comments on whether and how the General QM, which is intended to be available for all mortgage loans meeting its requirements, should be revised in light of the Patch’s planned expiration.
Before the ANPR was issued, the CFPB issued a request for information in June 2017, in connection with its statutorily mandated reassessment of the ATR/QM Rule. Also, beginning in January 2018, the Bureau issued several RFIs under its “Call for Evidence” that sought public comment on the range of the CFPB’s enforcement, supervision, rulemaking, market monitoring, and financial education activities. These included RFIs requesting information on the CFPB’s rulemaking process, the Bureau’s adopted regulations, and its new rulemaking authorities. In response to the RFIs, the CFPB received several hundred comments from lenders, industry groups, consumer advocacy groups, and individuals concerning the rule. Since the rule’s implementation, mortgage lending has been overwhelmingly confined to the origination of QM loans. According to the Urban Institute, which admits estimates of the non-QM market are difficult to make, non-QM originations in 2018 were $20 to $30 billion of $1.8 trillion total originations.
A large proportion of QM loans were originated under the Patch, including up to nearly a million loans that would not have qualified as QM loans without the Patch. In the ANPR, the Bureau cited estimates that there were approximately six million closedend first-lien residential mortgage loans in the U.S. in 2018, of which 52%, or roughly 3.12 million, were purchased or guaranteed by the GSEs. Of these 3.12 million loans, approximately one-third of GSE loans or one-sixth of all QM loans, had a debt-to-income (DTI) ratio greater than 43%, exceeding the maximum DTI ratio permitted for general QM loans. Reportedly, a large proportion of these above-43% DTI loans are loans to low- and moderate-income and minority borrowers.
It appears that while filling the Patch’s shoes will be challenging, it may prove to be the best course if the Patch expires so the mortgage market can continue to serve the range of borrowers served today. To better understand the issues around the Patch, some background is helpful.
In January 2014, when the ATR/ QM Rule became effective, having been finalized a year before, it implemented the provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Act) requiring that generally for closed-end residential mortgage loans, creditors must make a reasonable and good faith determination at or before closing that the consumer will have a reasonable ability to repay the loan. The Rule codified the eight factors the Act prescribed that must be considered in making such a determination.
Consistent with the Act, the Rule also provided the alternative of complying with the ability to repay requirement by originating a QM loan, which has both bright line standards and a presumption of compliance. To qualify as a QM, a mortgage, generally, must meet certain statutory restrictions under the act that prohibits “risky features” including: negative amortization; interest only or balloon payments; a term greater than 30 years; and points and fees exceeding specified limits.
A QM loan must be underwritten based on a fully amortizing schedule using the maximum rate permitted during the first five years, as well as a payment schedule that fully amortizes the loan over the loan term and takes into account all mortgage-related obligations. Underwriting must also include verifying and documenting the income and assets relied upon for repayment and complying with any guidelines or regulations established by the CFPB relating to the ratio of total monthly debtto-monthly income or alternative measures of ability to pay regular expenses after payment of total monthly debt. Mortgages meeting the QM requirements gain either a safe harbor or rebuttable presumption of compliance based on whether the Annual Percentage Rate (APR) for the loan is within 150 basis points of the Average Prime Offer Rate (APOR).
Under the Rule for a general QM, the creditor must consider and verify the consumer’s income and debt obligations in accordance with Appendix Q , which is based on a now obsolete Federal Housing Administration underwriting guide effective at the time the ATR/QM rule was developed. Most significantly, to qualify for a general QM, the ratio of the borrower’s total monthly DTI by consummation cannot exceed 43%, as determined in accordance with Appendix Q.
Additionally, because the CFPB in 2013 did not believe that a 43% DTI ratio represented the outer boundary of responsible lending, and the market was “especially fragile,” the rule established the Patch. As indicated, the rule provides that for seven years, until January 10, 2021, or until the GSEs are no longer under federal conservatorship, any loan eligible for Fannie Mae’s or Freddie Mac’s purchase or guarantee—whether or not it is actually purchased or guaranteed—is a QM. Importantly, the rule does not prescribe a maximum DTI limit for Patch loans. A loan can qualify if the DTI ratio exceeds 43%, as long as the loan meets the GSE’s standards including any compensating factors. Also, income and debt for patch loans and DTI ratios, are verified, considered, and calculated using GSE standards, not Appendix Q.
Under the Rule, FHA, the Department of Veterans Affairs, and the Rural Housing Service/ Department of Agriculture (RHS) also were authorized to define which loans under their programs are QMs, and each agency has separately done so. None of the agencies set a maximum DTI ratio to qualify, or require the use of Appendix Q. Alternative QMs also have been established for smaller creditors’ mortgages. For these QMs, there are no maximum DTI and Appendix Q requirements, although loans generally must be held in portfolio for three years.
Any type of creditor can originate a general QM or a patch QM. Only creditors that meet certain asset, volume, and other requirements can originate the Small Creditor Portfolio QM, the Small Creditor Balloon QM, and the new Smaller Institution QM. Additionally, only creditors with loans meeting FHA, VA, or RHS requirements can originate QMs under these agencies’ programs.
So, If It Isn’t Broken, Why Fix It?
Considering the data, the Patch has proven to be an effective and well-trodden path to providing safe, sound, and affordable QM loans to creditworthy borrowers who may not qualify for the General QM. In contrast, the General QM—with a relatively low maximum DTI requirement, and a static set of underwriting guidelines—has proven to be an unsatisfactory pathway to bring credit to many borrowers.
One main finding of the CFPB’s ATR/QM Rule Assessment Report was that Patch loans represent a “large and persistent” share of originations in the conforming segment of the mortgage market. Nevertheless, the ANPR made clear that the CFPB never intended to make the Patch permanent. The ANPR said that the CFPB did not presume that loans eligible for GSE purchase or guarantee, whether or not the GSEs are under conservatorship, are originated with appropriate consideration of the ability to repay.
Beyond that, the CFPB expressed concern that reliance on the GSEs’ underwriting standards could stifle innovation and the development of competitive private sector approaches to underwriting, as well as prevent a private securitization market rebound.
The Bureau also expressed the view that in the absence of the Patch, high DTI borrowers would likely choose FHA loans because of their higher DTI limits, non-QM or small creditor loans and, in some cases, smaller loan amounts or no loans at all. Finally, the U.S. Treasury Housing Reform Plan, issued in September 2019, setting forth the Trump administration’s vision for a privatized and more competitive future for the GSEs, specifically supported the CFPB decision to let the Patch expire. The decision to end the Patch and the administration’s plans for the GSEs are consistent, and it seems purposely so.
The ANPR sought comment on several questions including whether:
- The general QM classification should retain, substitute, or supplement its DTI ratio with another method to “measure a consumer’s personal finances,” such as “residual income;”
- A 43% DTI ratio is an appropriSince the Rule’s implementation, mortgage lending has been overwhelmingly confined to the origination of QM loans. According to the Urban Institute, which admits estimates of the non-QM market are difficult to make, non-QM originations in 2018 were $20 to $30 billion of $1.8 trillion total originations. M REPORT | 29 FEATURE ate measure for the General QM;
- QM status should be granted to loans with DTI ratios above prescribed limits if certain compensating factors are present;
- Appendix Q and/or other standards should be used to calculate and verify debt and income;
- A revised Rule should only maintain the statutory restrictions against risky features in lieu of maintaining a DTI ratio;
- A 43% DTI ratio should be required for a QM only at a particular APR level, such as 150 basis points over the APOR;
- The DTI criterion should be eliminated for certain loans depending on their pricing as long as they meet the statutory criteria, as examples: for a loan less than 150 basis points over the APOR—it will receive a QM safe harbor regardless of DTI; between 150 and 300 basis points over APOR—it will receive a rebuttable presumption regardless of its DTI; and for a loan above 300 basis points over APOR—it will receive a rebuttable presumption only if the DTI did not exceed 43%;
- The CFPB should amend the rule so that any performing loan that has been on a financial institution’s books for at least two years or some longer time would automatically convert to a QM; • The Rule should require the consideration of other credit risk factors in lieu of DTI such as credit score or LTV; and
- The Bureau should retain the current line separating safe harbor and rebuttable presumption QMs.
The ANPR also asked what amount of time would be needed to change the Rules.
More than 90 comments were filed by the ANPR’s deadline that will likely be considered along with the hundreds submitted in response to the RFIs. A few highlights from the ANPR comments and the comments on the RFIs as described by the Bureau follow. The comment from the Mortgage Bankers Association urged that the Patch not be allowed to expire, to avoid significant disruption to the mortgage market, until reforms were made to the existing General QM requirements.
A wide coalition of lenders, consumer, civil rights, and industry associations jointly asked that the DTI requirement either be dropped from the General QM definition entirely or possibly restricted to loans that were not prime or near prime. These organizations also asked that Appendix Q be dropped; that the existing ATR regulatory language be maintained and enhanced; and that the existing statutory safe product restrictions, which prohibit certain risky loan features and clarify provisions related to documentation and verification of income also be maintained.
These same commenters urged that the rule’s underwriting requirements, product restrictions, and safe harbor to incent compliance were sufficient to serve credit needs and avoid additional credit risk. These commenters also indicated that the DTI ratio was not intended to be a standalone measure of credit risk and is a weak predictor of default and ability to repay.
Others pointed out that a borrower’s rate was based on several relevant factors, not just the DTI ratio. Commenters also indicated that other standalone measures of consumers’ finances such as credit score were problematic for many borrowers.
Based on the commentary so far, it is reasonable to expect that the CFPB will soon propose changes to both the General QM and Appendix Q requirements. However, it is not yet clear what direction the proposal might take. Many representing the industry and consumer groups hope the proposal will include a more streamlined QM without the current DTI requirement for most loans that addresses the financing needs of creditworthy borrowers served today by both the General QM and the Patch, at a minimum.
Nevertheless, there are numerous crosscurrents in the debate and here are a few to consider. As indicated, the ANPR says that the CFPB believes that the expiration of the Patch and its lack of a fixed DTI limit might be made up by lending from the non-QM market or the FHA, which can lend without regard to a fixed DTI limit. Borrowers’ decisions to spend less for housing might also help. Many question, however, based on experience to date, whether non-QM lending will do much to pick up the slack when the Patch expires. Without legal certainty and a presumption of compliance, non-QM lending is still relatively scarce after nearly six years under the rule. Notably, most non-QM lending is still believed to be confined to meeting the needs of jumbo and other more affluent borrowers.
Others urge that FHA should not overtax its resources, diminish its focus on minority and first-time borrowers, and increase the government’s footprint and risk by serving a large amount of former Patch borrowers. Finally, it is also believed to be unrealistic to assume that an appreciable number of borrowers will be able to cut their housing loan amounts, considering housing costs in many areas of the nation. All of these factors, they urge, point to the need for a broader, more expansive QM to make up for the Patch’s expiration.
A recent article in a major publication expressed alarm that the GSEs have dramatically expanded their exposure to “risky”—essentially high DTI—mortgages that borrowers might not be able to repay in a downturn. Some who read the article note, however, that there is no real discussion of what the default risks might actually be considering the protections under the ATR/QM Rule and other relevant underwriting factors.
During the original ATR/QM rulemaking, the CFPB made DTI loan performance data publicly available for review and discussion. The article underlines the fact that even more data is likely to be essential for review as the current rulemaking process moves forward.
Finally, respondents to the CFPB’s RFI in connection with its reassessment of the Rule noted that high DTI lending can lead to a housing boom. Respondents also observed that a General QM limit of a 43% DTI ratio may help constrain such growth, but that these effects may have been diluted by the Patch’s allowance of loans with DTI ratios above 43%. Others have responded that QM standards were not intended to provide a new tool to address macroeconomic concerns, and that their purpose is simply to help ensure consumers are offered mortgage loans that they are able to repay.
The CFPB has made clear through its actions and pronouncements that dealing with the expiration of the Patch is among its highest priorities for the next year. As the rulemaking process progresses, considering the stakes involved, this issue is also likely to be an increasingly high priority for the public, companies, and organizations of all stripes. Stay tuned and stay involved as the discussion moves forward. The breadth of mortgage lending in the future is now at the top of the Bureau’s agenda