As rumored, the Consumer Financial Protection Bureau (“CFPB”) is proposing to revise its general qualified mortgage definition by adopting a loan pricing test. Specifically, under the proposal, a residential mortgage loan would not constitute a qualified mortgage (“QM”) if its annual percentage rate (“APR”) exceeds the average prime offer rate (“APOR”) by 200 or more basis points. The CFPB also proposes to eliminate its QM debt-to-income (“DTI”) threshold of 43%, recognizing that the ceiling may have unduly restrained the ability of creditworthy borrowers to obtain affordable home financing. That would also mean the demise of Appendix Q, the agency’s much-maligned instructions for considering and documenting an applicant’s income and liabilities when calculating the DTI ratio.
The CFPB intends to extend the effectiveness of the temporary QM status for loans eligible for purchase by Fannie Mae or Freddie Mac (the “GSE Patch”) until the effective date of its revisions to the general QM loan definition (unless of course those entities exit conservatorship before that date). That schedule will, the CFPB hopes, allow for the “smooth and orderly transition” away from the mortgage market’s persistent reliance on government support.
Last July, the CFPB started its rulemaking process to eliminate the GSE Patch (scheduled to expire in January 2021) and address other QM revisions. For the past five years, that Patch has solidified the post-financial crisis presence by Fannie Mae and Freddie Mac in the market for mortgage loans with DTIs over 43%. The GSE Patch was necessary, the CFPB determined, to cover that portion of the mortgage market until private capital could return. The agency estimates that if the Patch were to expire without revisions to the general QM definition, many loans either would not be made or would be made at a higher price. The CFPB expects that the amendments in its current proposal to the general QM criteria will capture some portion of loans currently covered by the GSE Patch, and will help ensure that responsible, affordable mortgage credit remains available to those consumers.
Adopting a QM Pricing Threshold
Although several factors may influence a loan’s APR, the CFPB has determined that the APR remains a “strong indicator of a consumer’s ability to repay,” including across a “range of datasets, time periods, loan types, measures of rate spread, and measures of delinquency.” The concept of a pricing threshold has been on the CFPB’s white board for some time, although it was unclear where the agency would set it. Many had guessed the threshold would be 150 basis points, while some suggested it should be as high as 250 basis points. While the CFPB is proposing to set the threshold at 200 basis points for most first-lien transactions, the agency proposes higher thresholds for loans with smaller loan amounts and for subordinate-lien transactions.
In addition, the CFPB proposes a special APR calculation for short-reset adjustable-rate mortgage loans (“ARMs”). Since those ARMs have enhanced potential to become unaffordable following consummation, for a loan for which the interest rate may change within the first five years after the date on which the first regular periodic payment will be due, the creditor would have to determine the loan’s APR, for QM rate spread purposes, by considering the maximum interest rate that may apply during that five-year period (as opposed to using the fully indexed rate).
Eliminating the 43% DTI Ceiling
Presently, for conventional loans, a QM may be based on the GSE Patch or, for non-conforming loans, it must not exceed a 43% DTI calculated in accordance with Appendix Q. Many commenters on the CFPB’s advanced notice of proposed rulemaking urged the agency to eliminate a DTI threshold, providing evidence that the metric is not predictive of default. In addition, the difficulty of determining what constitutes income available for mortgage payments is fraught with questions (particularly for borrowers who are self-employed or otherwise have nonstandard income streams). While the CFPB intended that Appendix Q would provide standards for considering and calculating income in a manner that provided compliance certainty both to originators and investors, the agency learned from “extensive stakeholder feedback and its own experience” that Appendix Q often is unworkable.
While the CFPB proposes to eliminate a DTI threshold for QMs, the agency indicates that rate spread combined with DTI would better predict early delinquency rates than either factor on its own. Accordingly, the CFPB requests comments on certain hybrid approaches, such as retaining a higher DTI limit but injecting more flexibility in verifying debt and income, or imposing a DTI limit only for loans above a certain pricing threshold.
Although under the proposed rule the general QM parameters would not include a DTI limit, creditors still would be required to consider DTI (or residual income) in making a general QM. In fact, in order to achieve QM status, the creditor would have to retain documentation of its consideration of one or both of those factors, such as by documenting that the creditor followed its standard procedures for considering the factors in connection with a specific loan, and/or by including an underwriter worksheet or final automated underwriting system certification.
The CFPB also proposes to retain requirements for the verification of income, and is considering providing a safe harbor to creditors using specified standards, such as those required by Fannie Mae or Freddie Mac, or under one of the government insurance/guarantee programs. The CFPB stated that those external standards appear reasonable and would provide greater compliance certainty – particularly with respect to verifying income for self-employed consumers.
The CFPB also is taking the opportunity to address unidentified deposits in the consumer’s bank account. The rule would require that the creditor generally must confirm that an inflow of funds into the consumer’s account is in fact income, and not, for example, the distribution of loan proceeds. However, the rule does not otherwise provide any standards for relying on bank statements or other types of documentation for borrowers with self-employment or nontraditional income sources.
Retention of Other QM Criteria
The proposal would retain many current elements of the general QM criteria. The existing limitations on QM product features and on points and fees would remain. The proposal also would preserve the current threshold separating safe harbor from rebuttable presumption QMs. Accordingly, a loan that otherwise meets the general QM loan definition would be a safe harbor QM if its APR exceeds the APOR for a comparable transaction by less than 1.5 percentage points (for first-lien transactions); all other QM loans (those with a rate spread at or above 1.5 but less than 2 percentage points) would be considered rebuttable presumption QMs.
Some commenters argued that the CFPB should trim back its QM definition, and rely only on the definition in the Dodd-Frank Act (e.g., prohibitions on certain loan features and a limitation on points and fees). However, the CFPB insists that some direct or indirect measure of the consumer’s finances is needed to ensure that consumers have a reasonable ability to repay. Others had suggested retaining a DTI limit but allowing for exemptions when compensating factors were present. However, the CFPB states that such exemptions would undermine the goal of compliance certainty, which is of particular importance to purchasers of mortgage loans concerned about potential assignee liability for violations of the statutory ability-to-repay requirements.
There also had been a suggestion that the CFPB would institute some type of results-oriented approach to gaining QM status by providing that loans that do, in fact, experience timely payments would be deemed to comply with the ability-to-repay requirement. However, the CFPB does not include that approach in this proposal.
As we previously noted, changes to the QM parameters also will likely affect the types of loans that are exempt from credit risk retention in securitizations (qualified residential mortgages, or “QRMs”). Although the purposes of the ability-to-repay rule and the credit risk retention rule are different, the multiple agencies responsible for defining QRMs are likely to continue prioritizing the conformity between the two sets of safe harbor loans.
While this proposal was expected last month, surely the agency’s rule drafters have been working diligently from home, weighing the input received from industry and housing advocates as the mortgage market shifted into pandemic, CARES Act relief mode. While low interest rates have kept loan applications pouring in, and default and forbearance rates are not as high as one might have predicted, the CFPB states that the pandemic has resulted in a contraction of mortgage credit availability for those who may be dependent on the GSE Patch or non-QMs for financing. It is undeniable that economic uncertainties will persist for those and other borrowers, and for creditors and investors.
The CFPB will accept comments on the QM revisions described above for 60 days. Then, the proposed rule indicates that the CFPB will recognize a 6-month delayed effective date after publication of the final rule. As to the expiration of the GSE Patch, the CFPB will accept comments on that proposal for 30 days. As indicated above, the expiration is proposed to take effect at the same time as the general QM revisions. For planning purposes, the CFPB indicated that it does not intend for that effective date to be prior to April 1, 2021, taking it well past the election in November.