CFPB’s Ability to Repay, Qualified Mortgages, Escrow, and HOEPA Rules Provide Clarity and Certain Opportunities
January 11, 2013
Authored by: Bryan Cave
The CFPB released its much-anticipated ability to repay (ATR) and qualified mortgage (QM) rules on January 10, 2013 after a field hearing attended by Bryan Cave in Baltimore, MD. At the same time, the CFPB issued a final rule amending Regulation Z (Truth in Lending) to implement Dodd-Frank Act (DFA) requirements for creditors to establish escrow accounts for higher-priced mortgage loans secured by a first lien on a principal dwelling, and a third rule to implement the DFA amendments to the Truth in Lending Act and the Real Estate Settlement Procedures Act expanding the types of mortgage loans that are subject to the protections of the Home Ownership and Equity Protections Act of 1994 (HOEPA) and modifying requirements with respect to homeownership counseling.
In the coming days, we will provide detailed analyses of these new rules. For now, the following addresses certain of the key provisions of the ATR and QM rules, including certain proposed exemptions and temporary measures intended to soften the impact of these changes on smaller lenders.
The ATR and QM rules are scheduled to take effect on January 10, 2014. However, the CFPB also has proposed possible adjustments to the final rules for certain specialized community-based lenders, housing stabilization programs, Fannie Mae and Freddie Mac refinancing programs, and small portfolio lenders (including many community banks, as explained below). The CFPB states that it would finalize those proposals this Spring so that they would also be effective on January 10, 2014.
One key issue resolved by the final rules is whether QMs will be afforded either a conclusive or, alternatively, a rebuttable presumption of compliance with the ATR requirements. Here, the CFPB drew a line that, according to Director Cordray during the field hearing in Baltimore, “has long been recognized as a rule of thumb to separate prime loans from subprime loans.” Specifically, the rule provides a conclusive presumption of ATR compliance—a so-called “safe harbor”—for loans that meet the definition of a qualified mortgage and that are not “higher-priced” under existing rules. All other qualified mortgages would only be afforded a rebuttable presumption of compliance with the new ATR rules.
This fleshes out a framework in which there are four ways to comply with ATR requirements:
(1) Satisfy the general ATR standards;
(2) Refinance a “non-standard mortgage” into a “standard mortgage”;
(3) Originate a “qualified mortgage”;
(4) Originate a “balloon-payment qualified mortgage” if you are a qualifying creditor (only a few creditors would have this option).
Unless the creditor can satisfy the ATR rules through one of the other three alternatives (refinancing a non-standard mortgage, or originating a qualified mortgage or balloon-payment qualified mortgage), the creditor will need to satisfy the ATR requirement. To do so, the creditor must make a reasonable and good faith determination, at or before consummation, that the consumer will have a reasonable ability to repay the loan according to its terms, including any mortgage-related obligations.
The final ATR rules identifies 8 factors that the creditor would be required to consider:
- The consumer’s current or reasonably expected income or assets, excluding the value of the dwelling and any real property attached to the dwelling;
- If the creditor relies on income fron the consumer’s employment in determining repayment ability, the consumer’s current employment status;
- The consumer’s monthly payment for the covered transaction;
- The consumer’s monthly payment for any other loan or HELOC given to the borrower by any creditor at or before consummation of the covered transaction (a “simultaneous loan”);
- The consumer’s monthly payment for certain mortgage-related obligations (such as property taxes and certain insurance premiums);
- The consumer’s current debt obligations, alimony and child support;
- The consumer’s monthly debt-to-income (DTI) ratio or residual income; and
- The consumer’s credit history.
Creditors will be deemed to comply with the ATR requirements when making qualified mortgages that are not higher-priced covered transactions. To be a QM, a loan must meet the following standards:
- provide for regular periodic payments that are substantially equal (except for ARMs or step-rate loans) that do not result in an increase in principal, allow the borrower to defer repayment of principal (e.g., interest-only or partially amortizing loans), or result in a balloon payment (except for balloon-payment qualifying mortgages);
- have a loan term of no more than 30 years;
- have total points and fees that do not exceed the permitted percentage of the total loan amount;
- be underwritten taking into account the monthly payment and any mortgage-related obligations, using the maximum interest rate that may apply during the first 5 years and periodic payments that will repay either (i) the outstanding principal and interest over the remaining term of the loan after the interest rate adjusts to the 5-year maximum or (ii) the loan amount over the loan term; and
- for which the creditor considers and verifies the consumer’s income or assets, and current debt, alimony and child support obligations.
In addition, and signficantly, the final rule varies from the proposal by requiring for qualified mortgages that the consumer’s total monthly DTI may not exceed 43 percent when the loan is consummated.
One bright spot is that the CFPB recognized that a strict qualified mortgage standard might hinder the recovery of the mortgage market.
“In light of the fragile state of the mortgage market as a result of the recent mortgage crisis,” the CFPB developed a second, temporary category of QMs that satisfy some, but not all, of the QM standards but nonetheless meet the underwriting standards for purchase by either (1) the GSEs as long as they operate under Federal conservatorship or receivership or (2) HUD, the VA, or USDA, or the Rural Housing Service (the “Federal agencies”). This accommodation will expire in a maximum of seven years or at such earlier time with respect to each of the GSEs comes out of conversatorship and with respect to the Federal agencies as their own QM rules (which they are authorized to promulgate) take effect.
The final form of the “rural balloon-payment qualified mortgage” provision is also very important. Mandated by the Dodd-Frank Act, this provision is designed to assure credit availability in rural areas, where some creditors may only offer balloon-payment mortgages. Loans are only eligible if they have a term of at least 5 years, a fixed-interest rate (this was not required in the original proposal), and meet certain basic underwriting standards; debt-to-income ratios must be considered but are not subject to the 43 percent general requirement.
Creditors are only eligible to make rural balloon-payment qualified mortgages if they originate at least 50 percent of their first-lien mortgages in counties that are rural or underserved, have less than $2 billion in assets, and (along with their affiliates) originate no more than 500 first-lien mortgages per year. The final rule improved on the proposal, which would have limited creditors to 100 mortgages per year. Creditors generally will be required to hold the loans in their portfolios for three years in order to maintain their “balloon-payment qualified mortgage” status.
Even small lenders that are not in rural or underserved communities should pay close attention to the final balloon qualified mortgage rules. In one of its most surprising moves, the CFPB coupled its final QM rules with a request for comment on the creation of a new category of QMs, similar to the one for rural balloon-payment loans, for loans without balloon-payment features that are originated and held in portfolio by small creditors. The new category would not be limited to lenders that operate predominantly in rural or underserved areas but would use the same general size thresholds and other criteria as the rural balloon-payment rules. The proposal also seeks comment on whether to increase the threshold separating safe harbor and rebuttable presumption QMs for both rural balloon-payment QMs and the new small portfolio QMs, in light of the fact that small creditors often have higher costs of funds than larger creditors. Specifically, the CFPB is proposing a threshold of 3.5 percentage points above “average prime offer rate” for first-lien loans. This constitutes an important possible product category for the overwhelming majority of institutions that are smaller than $2 billion in asset size. The comment period for this proposal ends on February 25, 2013.